Unit 7 Lecture Notes

While bitcoin is indeed free market money, it does not necessarily follow that bitcoin would succeed on a free market for money. The longer I think of this, the more I begin to consider the possibility that bitcoin is a free market solution to the problem of government control over money, but it is not necessarily the money that would be chosen on a market free of government control. For as long as governments place restrictions on money, bitcoin can thrive as a method of going around them, but if these restrictions are eased, that might deprive bitcoin of the oxygen it needs, demand for going around monetary restrictions.

Bitcoin is a technology built and optimized for one design consideration: resisting government capture, and nothing else. Bitcoin is not optimized for user experience, convenience, or speed of use; it sacrifices all these considerations to achieve immutability and resistance to censorship. This is extremely valuable in a world in which governments restrict individuals' monetary freedom, but how valuable is it in a world in which they do not?

The problem of bitcoin adoption is different from the adoption of any other technology or application in that bitcoin's adoption involves decisions about liquidity and cash balances. People cannot just wake up one morning and decide to only deal with bitcoin, they have obligations to pay or be paid in different currencies, and they have savings accumulated in different currencies. They want to maximize their chances of being able to pay the money that their sellers want in exchange for their goods, and to be paid the money that buyers want to pay them. An individual's choice of medium of exchange is primarily determined by the differing liquidity pools around them, or the different degrees of salability for different moneys, as explained by Menger and discussed in more detail in The Bitcoin Standard. An individual's choice of money is likely to be the money that has the largest pool of liquidity, allowing the individual the largest number of trading opportunities, and providing them the best chance of exchanging their goods with the least loss of value.

Salability is also a self-reinforcing trend, as was illustrated by gold and silver in the nineteenth century, and also explained in The Bitcoin Standard. A money with larger salability will be likely to be more attractive as a store of value than a money with less salability, and that in turn will lead to the more salable money becoming even more salable, while the less salable money continues to lose its salability. Consider for a moment the possibility that bitcoin does indeed succeed in destroying government fiat currencies through speculative attacks, in a manner similar to the second scenario discussed above. Or consider the possibility that governments move toward freer banking and a competitive monetary system, without moving to a gold standard, but by allowing individual enterprise to provide consumers with a wide variety of choices in their monetary medium. In other words, imagine a completely free market in the choice of money, and try to imagine the consequences it would have for bitcoin.

In such a free market, individuals will choose the money which they find to be the most saleable, and most likely to be exchanged for other goods and services. As it stands, the total value of over-ground mined gold, or the global liquidity pool of gold, is around 100 times larger than the total value of mined bitcoin, or the global liquidity pool of bitcoin. This is a natural outcome of gold's huge 6,000- year first-mover-advantage over bitcoin. Gold has been produced all over the world for millennia and is an indelible part of all human cultures that have viewed it as precious. Today it continues to be held by central banks, but also, is widely used as a store of value and medium of exchange all over the world. Gold is still the dowry necessary to get married all over the world. The majority of humans own some gold, either in the form of coins, bars, or jewelry. In a situation in which alternatives collapse, people are far more likely to go back to trading in gold because of the properties that gave it its monetary role in the first place, but more importantly perhaps, because of the very large pool of liquidity that has been accumulating over thousands of years.

The implication of this is that for the average individual who wants to sell a good or service in a post-fiat world the likelihood that their counterparty will have gold to pay is roughly 100 times the likelihood that they would have bitcoin to pay. That makes each individual far more likely to want to accept gold as money than bitcoin, and that, in turn, reinforces the same trend with all other individuals. As it stands, a free market in money is not likely to be beneficial to bitcoin, because in the one metric that matters most, liquidity, bitcoin is incomparable to gold. Bitcoin needs government controls and restrictions to drive demand for it. The freer the global market for money, the more likely that any monetary competition will lead to gold winning in a winner-take all scenario similar to how the nineteenth century competition between gold and silver unfolded. For bitcoin to have a chance, it needs government laws and restrictions to continue to drive people to look for hard money alternatives, thus increasing its value and the size of its pool of liquidity.

Beyond liquidity, and when it comes to issues of ease of use, many bitcoin promoters seem a little too enthusiastic in their assumptions on the ease of using bitcoin, and how willing people are to learn them. While I entirely agree that these technical barriers will be overcome by people who need to get around government restrictions, I am not sure there is a strong enough motivation to learn them in a world where these restrictions don't exist and people can default to using gold in all its tried and tested familiarity.

The non-digital nature of gold, and its physical heft and high cost of transfer compared to bitcoin are not serious obstacles for gold regaining a monetary role on a free market, they are only obstacles to the extent that they allow governments to prevent a global banking system to emerge around gold. In a free market, there is no reason that the most advanced payment technology implemented over fiat money or bitcoin could be used on top of gold. Instant digital payments with very few settlement transactions in physical gold are pretty straightforward to build from an engineering perspective, the real barrier to their development has always been political. In a world in which government restrictions on money disappear, the development of a gold based financial infrastructure is likely to be faster and more advanced than a bitcoin-based financial infrastructure, because of the larger liquidity of gold attracting more development and investment.

Ironically, it appears that bitcoin is dependent on the governments it was built to counter for its survival. A world without government abuse of money is a world in which bitcoin is superfluous, and monetary tradition and history will likely move us back to a gold-based monetary standard. For bitcoin to continue to succeed and grow, it requires governments to continue to follow bad monetary policies that drive people to hold more bitcoin, raising its price, increasing the pool of liquidity, making it more likely for others to join this pool of liquidity. The longer that bad government monetary policy continues, the more liquidity bitcoin is likely to amass, the closer it gets to gold's liquidity, and the better its chances of unseating gold as humanity's prime money in a free market. The more governments reform their monetary policies and allow their citizens financial freedom, the less demand there is for bitcoin, and the less likely bitcoin's network is to grow.