The Bitcoin Standard: The Decentralized Alternative to Central Banking

by Saifedean Ammous

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.

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 in the long run—are as old as human society itself.

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.

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.

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 second function of money: store of value. For a good to be salable across time it has to be immune to rot, corrosion, and other types of deterioration.

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 money whose supply is amenable to large increases.

We can understand money's hardness through understanding two distinct quantities related to the supply of a good: (1) the stock, which is its existing supply, consisting of everything that has been produced in the past, minus everything that has been consumed or destroyed; and (2) the flow, which is the extra production that will be made in the next time period. The ratio between the stock and flow is a reliable indicator of a good's hardness as money, and how well it is suited to playing a monetary role.

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.

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. This is a lesson worth remembering when we turn to the discussion of the soundness of government money

Being bulky and not easily divisible, however, meant cattle were not very useful to solve the problems of divisibility across scales, and so another form of money coexisted along with cattle, and that was salt. Salt was easy to keep for long durations and could be easily divided and grouped into whatever weight was necessary. These historical facts are still apparent in the English language, as the word pecuniary is derived from pecus, the Latin word for cattle, while the word salary is derived from sal, the Latin word for salt.

money that is easy to produce is no money at all, and easy money does not make a society richer; on the contrary, it makes it poorer by placing all its hard‐earned wealth for sale in exchange for something easy to produce.

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,

the existing stockpile of gold held by people around the world is the product of thousands of years of gold production, and is orders of magnitude larger than new annual production. Over the past seven decades with relatively reliable statistics, this growth rate has always been around 1.5%, never exceeding 2%.

Taxation and inflation had destroyed the wealth and savings of the people of Europe. New generations of Europeans came to the world with no accumulated wealth passed on from their elders, and the absence of a widely accepted sound monetary standard severely restricted the scope for trade, closing societies off from one another and enhancing parochialism as once‐prosperous and civilized trading societies fell into the Dark Ages of serfdom, diseases, closed‐mindedness, and religious persecution.

Whether in Rome, Constantinople, Florence, or Venice, history shows that a sound monetary standard is a necessary prerequisite for human flourishing, without which society stands on the precipice of barbarism and destruction.

Given that they were used physically, silver and gold complemented each other: gold's high stock‐to‐flow ratio meant it was ideal as a long‐term store of value and a means of large payments, but silver's lower value per unit of weight made it easily divisible into quantities suitable for smaller transactions and for being held for shorter durations. While this arrangement had benefits, it had one major drawback: the fluctuating rate of exchange between gold and silver created trade and calculation problems. Attempts to fix the price of the two currencies relative to one another were continuously self‐defeating, but gold's monetary edge was to win out.

Two particular technological advancements would move Europe and the world away from physical coins and in turn help bring about the demise of silver's monetary role: the telegraph, first deployed commercially in 1837, and the growing network of trains, allowing transportation across Europe. With these two innovations, it became increasingly feasible for banks to communicate with each other, sending payments efficiently across space when needed and debiting accounts instead of having to send physical payments. This led to the increased use of bills, checks, and paper receipts as monetary media instead of physical gold and silver coins.

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.

The fatal flaw of the gold standard at the heart of these two problems was that settlement in physical gold is cumbersome, expensive, and insecure, which meant it had to rely on centralizing physical gold reserves in a few locations—banks and central banks—leaving them vulnerable to being taken over by governments. As the number of payments and settlements conducted in physical gold became an infinitely smaller fraction of all payments, the banks and central banks holding the gold could create money unbacked by physical gold and use it for settlement.

wealth can't be generated by tampering with the money supply, that allowing a sovereign the control of the money can only lead to them increasing their control of everyone's life, and that civilized human living itself rests on the integrity of money providing a solid foundation for trade and capital accumulation.

The common name for government money is fiat money, from the Latin word for decree, order, or authorization.

It was the abandonment of sound money and its replacement with government‐issued fiat which turned the world's leading economies into centrally planned and government‐directed failures. As governments controlled money, they controlled most economic, political, cultural, and educational activity.

zeitgeist

The market for foreign exchange, at $5 trillion of daily volume, exists purely as a result of this inefficiency of the absence of a single global homogeneous international currency.

History has shown that governments will inevitably succumb to the temptation of inflating the money supply. Whether it's because of downright graft, “national emergency,” or an infestation of inflationist schools of economics, government will always find a reason and a way to print more money, expanding government power while reducing the wealth of the currency holders.

Should a currency credibly demonstrate its supply cannot be expanded, it would immediately gain value significantly.

A few reasons keep government money as the prime money of our time. First, governments mandate that taxes are paid in government money, which means individuals are highly likely to accept it, giving it an edge in its salability. Second, government control and regulation of the banking system means that banks can only open accounts and transact in government‐sanctioned money, thus giving government money a much higher degree of salability than any other potential competitor. Third, legal tender laws make it illegal in many countries to use other forms of money for payment. Fourth, all government moneys are still backed by gold reserves, or backed by currencies backed by gold reserves.

Gold has clearly not lost its monetary role; it remains the only final extinguisher of debt, the one money whose value is not a liability of anyone else, and the prime global asset which carries no counterparty risk. Access to its monetary role, however, has been restricted to central banks, while individuals have been directed toward using government money.

Sound money, then, according to Mises, is what the market freely chooses to be money, and what remains under the control of its owner, safe from coercive meddling and intervention. For as long as the money was controlled by anyone other than the owner, whoever controlled it would always face too strong an incentive to pilfer the value of the money through inflation or confiscation, and to use it as a political tool to achieve their political goals at the expanse of the holders.

A sound money, on the other hand, makes service valuable to others the only avenue open for prosperity to anyone, thus concentrating society's efforts on production, cooperation, capital accumulation, and trade.

As Friedrich Hayek put it: I don't believe we shall ever have a good money again before we take the thing out of the hands of government, that is, we can't take it violently out of the hands of government, all we can do is by some sly roundabout way introduce something that they can't stop.25

the importance of sound money can be explained for three broad reasons: first, it protects value across time, which gives people a bigger incentive to think of their future, and lowers their time preference. The lowering of the time preference is what initiates the process of human civilization and allows for humans to cooperate, prosper, and live in peace. Second, sound money allows for trade to be based on a stable unit of measurement, facilitating ever‐larger markets, free from government control and coercion, and with free trade comes peace and prosperity. Further, a unit of account is essential for all forms of economic calculation and planning, and unsound money makes economic calculation unreliable and is the root cause of economic recessions and crises. Finally, sound money is an essential requirement for individual freedom from despotism and repression, as the ability of a coercive state to create money can give it undue power over its subjects, power which by its very nature will attract the least worthy, and most immoral, to take its reins.

This is the essence of investment: as humans delay immediate gratification, they invest their time and resources in the production of capital goods which will make production more sophisticated or technologically advanced and extend it over a longer time‐horizon. The only reason that an individual would choose to delay his gratification to engage in risky production over a longer period of time is that these longer processes will generate more output and superior goods. In other words, investment raises the productivity of the producer.

The factor affecting time preference that is most relevant to our discussion, however, is the expected future value of money. In a free market where people are free to choose their money, they will choose the form of money most likely to hold its value over time.

What matters in money is its purchasing power, not its quantity, and as such, any quantity of money is enough to fulfil the monetary functions, as long as it is divisible and groupable enough to satisfy holders' transaction and storage needs. Any quantity of economic transactions could be supported by a money supply of any size as long as the units are divisible enough.

When it comes to investment, sound money creates an economic environment where any positive rate of return will be favorable to the investor, as the monetary unit is likely to hold onto its value, if not appreciate, thus strengthening the incentive to invest. With unsound money, on the other hand, only returns that are higher than the rate of depreciation of the currency will be positive in real terms, creating incentives for high‐return but high‐risk investment and spending. Further, as increases in the money supply effectively mean low interest rates, the incentive to save and invest is diminished while the incentive to borrow increases.

mendacious

Modern economics has formulated “The Impossible Trinity” to express the plight of modern central bankers, which states: No government can successfully achieve all three goals of having a fixed foreign exchange rate, free capital flows, and an independent monetary policy.

consensus taught in undergraduate macroeconomics courses across the world: that the central bank should be in the business of expanding the money supply at a controlled pace, to encourage people to spend more and thus keep the unemployment level sufficiently low. Should a central bank contract the money supply, or fail to expand it adequately, then a deflationary spiral can take place, which would discourage people from spending their money and thus harm employment and cause an economic downturn.

The Austrian theory of money posits that money emerges in a market as the most marketable commodity and most salable asset, the one asset whose holders can sell with the most ease, in favorable conditions.7 An asset that holds its value is preferable to an asset that loses value, and savers who want to choose a medium of exchange will gravitate toward assets that hold value over time as monetary assets.

the absence of control by government is a necessary condition for the soundness of money, seeing as government will have the temptation to debase its money whenever it begins to accrue wealth as savers invest in it.

By placing a hard cap on the total supply of bitcoins, as discussed in Chapter 8, Nakamoto was clearly unpersuaded by the arguments of the standard macroeconomics textbook and more influenced by the Austrian school, which argues that the quantity of money itself is irrelevant, that any supply of money is sufficient to run an economy of any size, because the currency units are infinitely divisible, and because it is only the purchasing power of money in terms of real goods and services that matters, and not its numerical quantity.

Unsound money, on the other hand, allows governments to buy allegiance and popularity by spending on achieving popular objectives without having to present the bill to their people. Government simply increases the money supply to finance any harebrained scheme it concocts, and the true cost of such schemes is only felt by the population in years to come when the inflation of the money supply causes prices to rise, at which point the destruction of the value of the currency can be easily blamed on myriad factors, usually involving some nefarious plots by foreigners, bankers, local ethnic minorities, or previous or future governments.

Unsound money is a particularly dangerous tool in the hands of modern democratic governments facing constant reelection pressure.

Bitcoin is the first example of digital cash.

Satoshi Nakamoto's motivation for Bitcoin was to create a “purely peer‐to‐peer form of electronic cash” that would not require trust in third parties for transactions and whose supply cannot be altered by any other party. In other words, Bitcoin would bring the desirable features of physical cash (lack of intermediaries, finality of transactions) to the digital realm and combine them with an ironclad monetary policy that cannot be manipulated to produce unexpected inflation to benefit an outside party at the expense of holders. Nakamoto succeeded

Crucially, the node that commits a valid block of transactions to the network receives a block reward consisting of brand‐new bitcoins added to the supply along with all the transaction fees paid by the people who are transacting.