The Bitcoin Standard: The Decentralized Alternative to Central Banking

by Saifedean Ammous

On October 31, 2008, a computer programmer going by the pseudonym Satoshi Nakamoto sent an email to a cryptography mailing list to announce that he had produced a “new electronic cash system that's fully peer-to-peer, with no trusted third party.”

But in October 2009, an Internet exchange2 sold 5,050 bitcoins for $5.02, at a price of $1 for 1,006 bitcoins, to register the first purchase of a bitcoin with money.3 The price was calculated by measuring the value of the electricity needed to produce a bitcoin. In economic terms, this seminal moment was arguably the most significant in bitcoin's life. Bitcoin was no longer just a digital game being played within a fringe community of programmers; it had now become

a market good with a price, indicating that someone somewhere had developed a positive valuation for it.

On May 22, 2010, someone else paid 10,000 bitcoins to buy two pizza pies worth $25, representing the first time that bitcoin was used as a medium of exchange. The token had needed seven months to transition...

Since then, the bitcoin network has grown in the number of users and transactions, and the processing power dedicated to it, while the value of its currency has risen quickly, e...

After eight years, it is clear that this invention is no longer just an online game, but a technology that has passed the market test and is being used by many for real-world purposes, with its exchange rate being regularly featured on TV, in newspapers, and on websites along with the exchange rates of national currencies.

Bitcoin can be best understood as distributed software that allows for transfer of value using a currency protected from unexpected inflation without relying on trusted third parties. In other words, bitcoin automates the functions of a modern central bank and makes them predictable and virtually immutable by programming them into code decentralized among thousands of network members, none of whom can alter the code without the consent of the rest. This makes bitcoin the first demonstrably reliable operational example of digital cash and digital hard money.

While bitcoin is a new invention of the digital age, the problems it purports to solve—namely, providing a form of money that is under the full command of its owner and likely to hold its value...

As an economist with an engineering background, I have always sought to understand a technology in terms of the problems it purports to solve, which allows for the identification of its functional essence and its separation from incidental, cosmetic, and insignificant characteristics.

By understanding the problems money attempts to solve, it becomes possible to elucidate what

makes for sound and unsound money, and to apply that conceptual framework to understand how and why various goods, such as seashells, beads, metals, and government money, have served the function of money, and how and why they may have failed a...

Sound money allows people to think about the long term and to save and invest more for the future. Saving and investing for the long run are the key to capital accumulation and the advance of human civilization.

Money is the information and measurement system of an economy, and sound money is what allows trade, investment, and entrepreneurship to proceed on a solid basis, whereas unsound money throws these processes into disarray.

Sound mo...

also an essential element of a free society as it provides for an effective bulwark ag...

Should you

come out of reading this book thinking that the bitcoin currency is something worth owning, your first investment should not be in buying bitcoins, but in time spent understanding how to buy, store, and own bitcoins securely. It is the inherent nature of bitcoin that such knowledge cannot be delegated or outsourced. There is no alternative to personal responsibility for anyone interested in using this network, and that is the real investment that needs to be made to get into bitcoin.

Bitcoin is the newest technology to serve the function of money—an invention leveraging the technological possibilities of the digital age to solve a problem that has persisted for all of humanity's existence: how to move economic value across time and space.

The simplest way for people to exchange value is to exchange valuable goods with one another. This process of direct exchange is referred to as barter, but is only practical in small circles with only a few goods and services produced.

problem of coincidence of wants

lack of coincidence in scales:

lack of coincidence in time frames: what you want to sell may be perishable but what you want to buy is more durable and valuable, making it hard to accumulate enough of your perishable good to exchange for the durable good

lack of coincidence of locations:

These three problems make direct exchange highly impractical and result in people needing to resort to performing more layers of exchange to satisfy their economic needs.

indirect exchange:

A good that assumes the role of a widely accepted medium of exchange is called money.

Being a medium of exchange is the quintessential function that defines money—in other words, it is a good purchased not to be consumed (a consumption good), nor to be employed in the production of other goods (an investment, or capital good), but primarily for the sake of being exchanged for other goods. While investment is also meant to produce income to be exchanged for other goods, it is distinct from money in three respects: first, it offers a return, which money

does not offer; second, it always involves a risk of failure, whereas money is supposed to carry the least risk; third, investments are less liquid than money, necessitating significant...

This can help us understand why there will always be demand for money, and why holding investments can...

Human life is lived with uncertainty as a given, and humans cannot know for sure when they wil...

It is common sense, and age-old wisdom in virtually all human cultures, for individuals to want to store some portion of their wealth in the form of money, because it is the most liquid holding possible, allowing the holder to quickly liquidate if she needs to, and because it involves less risk than any investment.

The price for the convenience of holding money comes in the form of the forgone consumption that could have been had with it, and in the form of the

forgone returns that could have been made fro...

key property that leads to a good being adopted freely as money on the market, and that is salability—the ease with which a good can be sold on the market whenever its holder desires, with the least loss in its price.

There is nothing in principle that stipulates what should or should not be used as money. Any person choosing to purchase something not for its own sake, but with the aim of exchanging it for something else, is making it de facto money, and as people vary, so do their opinions on, and choices of, what constitutes money. Throughout human history, many things have served the function of money: gold and silver, most notably,

but also copper, seashells, large stones, salt, cattle, government paper, precious stones, and even alcohol and cigarettes in certain conditions. People's choices are subjective, and so there is no “right” and “wrong” choice of money. There are, however, consequences to choices.

The relative salability of goods can be assessed in terms of how well they address the three facets of the problem of the lack of coincidence of wants mentioned earlier: their salabi...

A good that is salable across scales can be conveniently divided into smaller units or grouped into larger units, thus allowing the holder to sell it in whichever quantity he desires. Salability across space indicates an ease of transporting the good or carrying it along as a person travels, and this has led to good monetary media generally having hi...

large number of goods that could potentially serve the function of money. It is the third element, salability across...

A good's salability across time refers to its ability to hold value into the future, allowing the holder to store wealth in it, which is the s...

For a good to be salable across time it has to be immune to rot, corrosion, and othe...

Physical integrity through time, however, is a necessary but insufficient condition for salability across time, as it is possible for a good to lose its value significantly even if its physical condition remains unchanged. For the good to maintain its value, it is also necessary that the supply of

the good not increase too drastically during the period in which the holder owns it.

common characteristic of forms of money throughout history is the presence of some mechanism to restrain the production of new units of the good to ...

The relative difficulty of producing new monetary units determines the hardness of money: money whose supply is hard to increase is known as hard money, while easy money is mo...

The higher the ratio of the stock to the flow, the more likely a good is to maintain its value over time and thus be more salable across time.

If people choose a hard money, with a high stock-to-flow ratio, as a store of value, their purchasing of it to store it would increase demand for it, causing a rise in its price, which would incentivize its producers to make more of it. But because the flow is small compared to the existing supply, even a large increase in the new production is unlikely to depress the price significantly. On the other hand, if people chose to store their wealth in an easy money, with a

low stock-to-flow ratio, it would be trivial for the producers of this good to create very large quantities of it that depress the price, devaluing the good, expropriating the wealth of the savers, and destroying the good's salability across time.

I like to call this the easy money trap: anything used as a store of value will have its supply increased, and anything whose supply can be easily increased will destroy the wealth of those who used it as a store of value. The corollary to this trap is that anything that is successfully used as money will have some natural or artificial mechanism that restricts the new flow of the good into the market, maintaining its value across time. It therefore follows that for something to assume a monetary role, it has to be costly to produce, otherwise...

Whenever a natural, technological, or political development resulted in quickly increasing the new supply of a monetary good, the good would lose its monetary status and be replaced by other media of exchange with a more reliably high stock-to-flow ratio, as will be discussed in the next chapter. Seashells were used as money when they were hard to find, loose cigarettes are used as money in prisons because they are hard to procure or produce, and with national currencies, the lower t...