The Bitcoin Standard: The Decentralized Alternative to Central Banking

by Saifedean Ammous

But its mere existence is an insurance policy that will remind governments that the last object the establishment could control, namely, the currency, is no longer their monopoly. This gives us, the crowd, an insurance policy against an Orwellian future.

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.

Only with such an understanding, and only after extensive and thorough research into the practical operational aspects of owning and storing bitcoins, should anyone consider holding value in Bitcoin. While bitcoin's rise in market value may make it appear like a no‐brainer as an investment, a closer look at the myriad hacks, attacks, scams, and security failures that have cost people their bitcoins provides a sobering warning to anyone who thinks that owning bitcoins provides a guaranteed profit. 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.

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

Further, wide acceptance of a medium of exchange allows all prices to be expressed in its terms, which allows it to play the third function of money: unit of account.

A one‐time collapse in the value of a monetary medium is tragic, but at least it is over quickly and its holders can begin trading, saving, and calculating with a new one. But a slow drain of its monetary value over time will slowly transfer the wealth of its holders to those who can produce the medium at a low cost.

The gold standard allowed for unprecedented global capital accumulation and trade by uniting the majority of the planet's economy on one sound market‐based choice of money. Its tragic flaw, however, was that by centralizing the gold in the vaults of banks, and later central banks, it made it possible for banks and governments to increase the supply of money beyond the quantity of gold they held, devaluing the money and transferring part of its value from the money's legitimate holders to the governments and banks.

For anything to function as a good store of value, it has to beat this trap: it has to appreciate when people demand it as a store of value, but its producers have to be constrained from inflating the supply significantly enough to bring the price down. Such an asset will reward those who choose it as their store of value, increasing their wealth in the long run as it becomes the prime store of value, because those who chose other commodities will either reverse course by copying the choice of their more successful peers, or will simply lose their wealth.

It is the author's opinion that the history of China and India, and their failure to catch up to the West during the twentieth century, is inextricably linked to this massive destruction of wealth and capital brought about by the demonetization of the monetary metal these countries utilized.

This is a historical lesson of immense significance, and should be kept in mind by anyone who thinks his refusal of Bitcoin means he doesn't have to deal with it. History shows it is not possible to insulate yourself from the consequences of others holding money that is harder than yours.

thanks to the popularity of the most dangerous and absurd of all Keynesian fallacies, the notion that government spending on military effort would aid economic recovery. All spending is spending, in the naive economics of Keynesians, and so it matters not if that spending comes from individuals feeding their families or governments murdering foreigners: it all counts in aggregate demand and it all reduces unemployment! As an increasing number of people went hungry during the depression, all major governments spent generously on arming themselves, and the result was a return to the senseless destruction of three decades earlier.

As these lines are written, it is Venezuela's turn to go through this travesty and witness the ravages of the destruction of money, but this is a process that has occurred 56 times since the end of World War I, according to research by Steve Hanke and Charles Bushnell, who define hyperinflation as a 50% increase in the price level over a period of a month.

While microeconomics has focused on transactions between individuals, and macroeconomics on the role of government in the economy, the reality is that the most important economic decisions to any individual's well‐being are the ones they conduct in their trade‐offs with their future self.

The slowly declining marginal utility of holding money means demand for money at the margin will not vary significantly. Combining this with an almost constant supply results in a relatively stable market value for money in terms of goods and services. This means money is unlikely to appreciate or depreciate significantly, making it a lousy long‐term investment but a good store of value. An investment would be expected to have a significant appreciation potential, but also carry a significant risk of loss or depreciation. Investment is a reward for taking risk, but sound money, having the least risk, offers no reward.

Only Switzerland, which remained on an official gold standard until 1934, and continued to back its currency with large reserves of gold until the early 1990s, has continued to have a high savings rate, standing as the last bastion of low‐time‐preference Western civilization with a savings rate in the double digits, as every other Western economy has plummeted into the single digits and even to negative saving rates in some cases. The average savings rate of the seven largest advanced economies12 was 12.66% in 1970, but has dropped to 3.39% in 2015, a fall of almost three‐quarters. While savings rates have plummeted across the western world, indebtedness continues to rise. The average household in the West is indebted by more than 100% of its annual income, while the total debt burden of the various levels of government and households exceeds GDP by multiples, with significant consequences.

Such numbers have become normalized as Keynesian economists assure citizens that debt is good for growth and that saving would result in recessions. One of the most mendacious fantasies that pervades Keynesian economic thought is the idea that the national debt “does not matter, since we owe it to ourselves.” Only a high‐time‐preference disciple of Keynes could fail to understand that this “ourselves” is not one homogeneous blob but is differentiated into several generations—namely, the current ones which consume recklessly at the expense of future ones. To make matters worse, this phrase is usually followed by emotional blackmail along the lines of “we would be short‐changing ourselves if we didn't borrow to invest for our future.”

Scarcity is the fundamental starting point of all economics, and its most important implication is the notion that everything has an opportunity cost. In the capital market, the opportunity cost of capital is forgone consumption, and the opportunity cost of consumption is forgone capital investment. The interest rate is the price that regulates this relationship: as people demand more investments, the interest rate rises, incentivizing more savers to set aside more of their money for savings. As the interest rate drops, it incentivizes investors to engage in more investments, and to invest in more technologically advanced methods of production with a longer time horizon. A lower interest rate, then, allows for the engagement of methods of production that are longer and more productive: society moves from fishing with rods to fishing with oil‐powered large boats.

A modern economy with a central bank is built on ignoring this fundamental trade‐off and assuming that banks can finance investment with new money without consumers having to forgo consumption. The link between savings and loanable funds is severed to the point where it is not even taught in the economics textbooks any more,7 let alone the disastrous consequences of ignoring it.

At these artificially low interest rates, businesses take on more debt to start projects than savers put aside to finance these investments. In other words, the value of consumption deferred is less than the value of the capital borrowed.

This shortage of capital is not immediately apparent, because banks and the central bank can issue enough money for the borrowers—that is, after all, the main perk of using unsound money. In an economy with sound money, such manipulation of the price of capital would be impossible: as soon as the interest rate is set artificially low, the shortage in savings at banks is reflected in reduced capital available for borrowers, leading to a rise in the interest rate, which reduces demand for loans and raises the supply of savings until the two match.

By constantly expanding the money supply, central banks' monetary policy makes saving and investment less attractive and thus it encourages people to save and invest less while consuming more. The real impact of this is the widespread culture of conspicuous consumption, where people live their lives to buy ever‐larger quantities of crap they do not need. When the alternative to spending money is witnessing your savings lose value over time, you might as well enjoy spending it before it loses its value.

If society were a little girl in that marshmallow experiment, Keynesian economics seeks to alter the experiment so that waiting would punish the girl by giving her half a marshmallow instead of two, making the entire concept of self‐control and low time preference appear counterproductive. Indulging immediate pleasures is the more likely course of action economically, and that will then reflect on culture and society at large. The Austrian school, on the other hand, by preaching sound money, recognizes the reality of the trade‐off that nature provides humans, and that if the child waits, there will be more reward for her, making her happier in the long run, encouraging her to defer her gratification to increase it.

A currency that appreciates in value incentivizes saving, as savings gain purchasing power over time. Hence, it encourages deferred consumption, resulting in lower time preference. A currency that depreciates in value, on the other hand, leaves citizens constantly searching for returns to beat inflation, returns that must come with a risk, and so leads to an increase in investment in risky projects and an increased risk tolerance among investors, leading to increased losses.

Further, an economy with an appreciating currency would witness investment only in projects that offer a positive real return over the rate of appreciation of money, meaning that only projects expected to increase society's capital stock will tend to get funded. By contrast, an economy with a depreciating currency incentivizes individuals to invest in projects that offer positive returns in terms of the depreciating currency, but negative real returns. The projects that beat inflation but do not offer positive real returns effectively reduce society's capital stock, but are nonetheless a rational alternative for investors because they reduce their capital slower than the depreciating currency.

Being predisposed to focus on the future, individuals with a low time preference are less likely to engage in conflict than those with a present orientation. Conflict is by its very nature destructive, and in most cases, intelligent and future‐oriented people understand that there are no winners in violent conflict, because the winners will likely suffer more losses than if they had just abstained from taking part in the conflict in the first place. Civilized societies function on the premise that people respect one another's wills, and if there are conflicts, they attempt a peaceful resolution. Should an amicable solution not be found, people are more likely to part ways and avoid each other than continue to agitate and remain in conflict. This helps explain why prosperous civilized societies generally do not witness much crime, violence, or conflict.

Limited versus Omnipotent Government In his sweeping history of five centuries of Western civilization, From Dawn to Decadence, Jacques Barzun identifies the end of World War I as the crucial turning point to begin the decadence, decay, and demise of the West. It was after this war that the West suffered from what Barzun terms “The Great Switch,” the replacement of liberalism by liberality, the impostor claiming its mantle but in reality being its exact opposite.14 Liberalism triumphed on the principle that the best government is that which governs least; now for all the western nations political wisdom has recast this ideal of liberty into liberality. The shift has thrown the vocabulary into disorder.

Sound money, then, enforced a measure of honesty and transparency on governments, restricting their rule to within what was desirable and tolerable to the population. It allowed for society‐wide honest accounting of costs and benefits of actions, as well as the economic responsibility necessary for any organization, individual, or living being to succeed in life: consumption must come after production.

Gold became the leading global monetary standard because its new production was always a reliably tiny percentage of its existing supply, making goldmining a highly uncertain and unprofitable business, thus forcing more and more of the world's capital and labor to be directed toward the production of nonmonetary goods.

No other ostensibly private industry enjoys such an exorbitant privilege, combining the highest rates of profitability in the private sector with the protection of the public sector.

Both forms of payment have their advantages and drawbacks, and most people resort to a combination of the two in their economic transactions. Before the invention of Bitcoin, intermediated payments included (though were not limited to) all forms of digital payment. The nature of digital objects, since the inception of computers, is that they are not scarce. They can be reproduced endlessly, and as such it was impossible to make a currency out of them, because sending them will only duplicate them. Any form of electronic payment had to be carried out via an intermediary because of the danger of double‐spending: there was no way of guaranteeing that the payer was being honest with his funds, and not using them more than once, unless there was a trusted third party overseeing the account and able to verify the integrity of the payments carried out. Cash transactions were confined to the physical realm of direct contact, while all digital forms of payments had to be supervised by a third party.

The expansionary monetary policies of modern fiat economies and economists have never won the market test of adoption freely, but have instead been imposed through government laws, as discussed earlier.

It is a misnomer to call raw materials resources, because humans are not passive consumers of manna from heaven. Raw materials are always the product of human labor and ingenuity and thus humans are the ultimate resource, because human time, effort, and ingenuity can always be used to produce more output.

The eternal dilemma humans face with their time concerns how to store the value they produce with their time through the future. While human time is finite, everything else is practically infinite, and more of it can be produced if more human time is directed at it. Whatever object humans chose as a store of value, its value would rise, and because more of the object can always be made, others would produce more of the object to acquire the value stored in it. The Yapese had O'Keefe bringing explosives and advanced boats to make more Rai stones for them and acquire the value stored in the existing stones. Africans had Europeans bringing boats full of beads to acquire the value stored in their beads. Any metal other than gold that was used as a monetary medium was overproduced until its price collapsed. Modern economies have Keynesian central banks forever pretending to fight inflation while gradually or quickly eroding the value of their money, as discussed in Chapter 4.

No coin other than Bitcoin can lay a credible claim to being outside the control of anyone else, and as such, the entire point of utilizing the extremely complex structure underpinning Bitcoin is moot. There is nothing original or difficult about copying Bitcoin's design and producing a slightly different copycat, and thousands have done this so far. With time, one can expect more and more of these coins to enter the market, diluting the brand of all the other altcoins. Non‐Bitcoin digital currencies are, in the aggregate, easy money. No single altcoin can be considered on its own merits, because they are all indistinguishable in what they perform, which is also what Bitcoin performs, but very distinguishable from Bitcoin in that their supply and design can easily be altered, whereas Bitcoin's monetary policy is for all intents and purposes set in stone.

Contracts Currently, contracts are drafted by lawyers, judged by courts, and enforced by the police. Smart contract cryptographic systems such as Ethereum encode contracts into a blockchain to make them self‐executing, with no possibility for appeal or reversal and beyond the reach of courts and police. “Code is law” is a motto used by smart contract programmers. The problem with this concept is that the language lawyers use to draft contracts is understood by far more people than the code language used by smart contract drafters.