Unit 1 Lecture Notes

In The Bitcoin Standard, I argued that Bitcoin is evolving and scaling in a manner similar to that of the gold standard, with on-chain transactions similar to the rare, expensive, and highly secure movements of physical gold, while second layer systems with less strict security requirements handle more common and frequent payments. In the same way that a bank under the gold standard would transfer ownership of a gold bar from a payer to a payee without physically moving the gold bar itself, Bitcoin banks, exchanges, and websites can all transfer bitcoins on hand without registering each movement on-chain, thus saving on transaction costs; For transfers among themselves, they'd net these movements to further reduce transaction costs. On-chain transactions, like physical movements of gold, will increasingly be used for final settlement instead of individual payments. The hardness of Bitcoin, like the hardness of gold before it, will likely make it the most attractive store of value, and thus the preferred method of payment over other digital or government currencies that don't have the same hardness.

While on-chain bitcoin transactions are clearly preferable to second layer off-chain transactions, engineering realities discussed in detail in The Bitcoin Standard mean on-chain transactions simply cannot be used for global mass payments. If demand for bitcoin as a hard money grows, the choice that many will face is not between bitcoin on-chain transactions and second-layer transactions, but rather, between bitcoin second layer transactions and second-layer transactions on more centralized networks running on easy government money. Whatever one may think about second layer solutions and the trust involved in custodial and clearing services, their growth and development seem highly likely if the demand for bitcoin as a hard money is larger than the demand for it as a payment network with no trusted third parties.

In this, the first of The Bitcoin Standard Research Bulletin, we will delve in more detail into how this Bitcoin Standard can work, in particular with regards to central banking and fractional reserve banking. We begin by exploring the possibility of central banks adopting bitcoin as a reserve asset, before moving on to discussing fractional reserve banking, whether it is necessary or possible in a free market, the academic debate about it, and then assess how likely it is to develop on top of bitcoin. Building on that analysis, we analyze the likelihood that growing financial products and services on top of bitcoin could lead to the manipulation of its price.

Source: Saylor Academy, Bitcoin, Central Banking and Fractional Reserve Banking
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