Bitcoin from the Perspective of Good Money Pt. 2
This is part to 2 of my series looking at Bitcoin from the Perspective of Good Money. Let’s get into why bitcoin is good money.
Bitcoin
Bitcoin’s price is determined by the market. By definition, it is sound money. Its price today is hovering around $11,000 CAD with almost $7.7 billion in volume with the last 24 hours. This is impressive for a decentralized currency that also functions as its own central bank. But just a drop in the bucket when compared to the $5.1 trillion in volume that is traded every day. It’s only been 9 years, and its more than just a currency as we will see below.
Bitcoin is a payment system and currency in one. The current state of ‘account balances’ and transactions, arrives at consensus through a collective, decentralized network of participants. Now this is the novel aspect of Bitcoin. We can arrive at consensus of who owns what without needing a central authority such as a government or bank. We arrive at this consensus through a vast network of nodes and miners (mining nodes) that all run a copy of Bitcoin’s software. This software contains the rules as well as the shared public ledger of transactions.
Rules of Bitcoin
Looking at a couple core rules in Bitcoin we can begin to understand why this technology is so powerful. There are rules in the core protocol and transactional level rules in Bitcoin. One of the most important protocol rules relates to supply. Bitcoin has a finite 21 million coins that will ever be in existence hardcoded into the core software. The issuance (or inflation schedule) of these coins is also baked right into the protocol.
Today there are 17,168,838 bitcoins in circulation. Tomorrow there will be an additional 1800. New bitcoin are minted into the system every 10 min. The current reward for mining a block is 12.5 bitcoin. Its inflation schedule is halved every 4 years. In 2009, It started with 50 new bitcoins every 10 min, then 25 in 2013, 12.5 in 2016, and on May 24, 2020 6.25 bitcoin will be issued every 10 min. This continues until the supply is exhausted. This means that not only is bitcoin inherently scarce, but the inflation of the currency is known and predictable. You can know, almost exactly to the 10-min interval, how much bitcoin will be in circulation at any given time. Allowing you to make financial decisions knowing the future rate of inflation; the core concept of ideal money.
How is Bitcoin Secure
How does bitcoin prevent coins from being printed or avoid fraudulent transactions? Transactional rules. If you’re sending a bitcoin transaction with bitcoin you do not have, the network will reject the transaction as invalid. It knows this because every bitcoin transaction relates to a previous transaction. It is very easy to tell if you have bitcoin as there will always be a valid corresponding transaction prior, that is verifiable on the blockchain. This trail of transactions is publicly available to anyone and goes all the way back to the first transaction ever. This is a growing historical ledger of transactions and it is called the blockchain.
This software, including the public ledger, is distributed and run by tens of thousands of computers all over the world. Changes can not be made to these rules unless all these computers agree. This is not an easy thing to do. But that is a very good thing, if your goal is good money.
How does all this happen? Besides the software and network, it has almost everything to do with mining.
Mining Bitcoin
Mining is how new ‘blocks’ of bitcoin transactions are validated and added to the growing blockchain. There really is not any mining, but the idea is that there is a lot of work involved. Miners use very expensive, specialized computers to work to find a very difficult math solution. The math problem is designed to be difficult so that it takes approximately 10 minutes to solve. The reason for this is two-fold, to maintain the predictable inflation schedule of new bitcoin, and to ensure there is an opportunity cost to mining on invalid blocks.
To expand on the latter, look at this picture below.
This is a single bitcoin miner. Brand new the cost was $1,300. Most bitcoin miners now have hundreds or thousands of these working around the clock. These machines also consume a significant amount of energy, this one consumes about $135/mo worth of electricity. The capital costs, variable cost of energy, and overhead help deter bad actors from spending their time mining invalid blocks. Additionally, for solving the problem and mining a block, the reward is 12.5 BTC. That is about $132,000 today, creating a strong incentive structure for good miners.
The concept of mining is not intuitive. Its purpose is to maintain the integrity of bitcoin’s blockchain by arriving at consensus on the current state of transactions. Mining is a competitively driven process. To win the block reward, and add the next block to the growing chain, it takes a lot of work (energy & powerful equipment). A miner’s chances of solving the block is proportionate to the effort put in relative to the aggregate of all miner’s effort around the world.
This should have given you some insight on how bitcoin arrives at its ability to be good money.
Bitcoin as Good Money
Recalling what we now know about money, bitcoin should begin to look like a strong option for good, ideal, sound money. We know its scarce and has a predictable issuance. Its durable because code can never be destroyed. Bitcoins are divisible to 8 decimal places, providing 100,000,000 satoshis (smallest divisible unit) of spendable units in each bitcoin. It’s infinitely portable and can be stored anywhere. Your ownership of bitcoin is represented by a private key (a password consisting of random alpha numeric digits), and can be written down on paper or saved on a hard drive. The intrinsic value of bitcoin has been of much debate. The argument for its intrinsic value is quite fascinating and states:
Bitcoin is both a payment system and a money. The payment system is the source of value, while the accounting unit merely expresses that value in terms of price. The unity of money and payment is its most unusual feature, and the one that most commentators have had trouble wrapping their heads around.
On the other hand Peter Schiff often uses the analogy of money backed by commodities having intrinsic value. He uses the example of gold being used as jewelry or cigarettes used as currency in jail can still be smoked. Peter hands down holds the title for the funniest criticism of bitcoin having no intrinsic value by stating, “You can’t smoke a bitcoin.” Peter Schiff is a goldbug, and he shares a common ideology with bitcoin. Bitcoiners and Schiff alike believe the current system is falling apart and we need a better standard for money. He has not quite come around to believing the benefits bitcoin has over gold are greater than being backed by a useable commodity.
Intrinsic value may not even matter. If we give something value, it has value. If we value a verifiable, trustless, system of peer-to-peer cash, then bitcoin has value. There is a growing market for it, it is used as a medium of exchange, and is definitely used as a storage of wealth. How much of it speculative? Likely a lot right now. But this is a baby currency with huge aspirations, its 9 years old, with a 99.992% uptime. Bitcoin requires legitimacy, larger scale investors, and greater adoption which helps reduce speculation and volatility, making it much more stable money.
Venezuela
Venezuela is one of the best cases we have so far for a non-speculative, utility-driven use case for bitcoin. The Venezuelan government has long been a country almost completely dependent on its oil exports. Oil accounts for 90% of the countries exports. This reliance brought Venezuela to be one of the riches countries in Latina America during the oil boom (2000–2014). But massive spending, that was criticized even at high oil prices, could not be sustained at prices half that. In a little over 6 years, the country’s currency, the bolivar, lost 99.9997% of its value.
If as a Venezuelan you had saved up $100,000 worth of bolivar, today your savings would be worth $0.30. And it does not look to be slowing down either. The International Monetary Fund’s recent report, Outlook on the Americas: A Tougher Recovery “project[s] a surge in inflation to 1,000,000 percent by end-2018 to signal that the situation in Venezuela is similar to that in Germany in 1923 or Zimbabwe in the late 2000’s”. It is obviously a complicated situation. The Venezuelan government has even tried to issue its own cryptocurrency, backed by its oil reserves to take control of the situation. This might sound like some commodity-backed sound money, but the government is still bringing this into law and accepting it as payment for taxes. It will be interesting to see how they rally local confidence in this currency apparently redeemable for barrels of oil and how they will handle “proof of reserves”.
While all this has been going on, bitcoin volume against the bolivar has skyrocketed. Local bitcoins, the largest network for buying and selling bitcoin in person and online, has data below showing this recent movement.
Other than this data there is not a whole lot we know about bitcoin and Venezuela, but it definitely being used as a storage of wealth to shelter against this incredible inflation.
Conclusion
These are exciting times, but still such early days for the currency. Bitcoin still has its own challenges to overcome. I’ll be writing about it next.
But finally, let’s look at gold one last time. The total market cap of all gold in existence is 7.8 trillion USD. If Bitcoin is a better gold because its more secure, easily transferred anywhere almost instantly, then we can expect it to capture some percent of the gold hoarder market. If bitcoin were to capture just 20% of that market, its price would be $74,285 USD each. This is not including the value of bitcoin’s utility as a payment system or the fact that there are likely >3 million bitcoin lost forever reducing the total supply. If bitcoin ever becomes a reserve currency, we can expect the price to be many multiples of that.
Price is not everything, in fact, at this stage its a silly measure of success. But what Bitcoin does offer us is a truly decentralized, trust-less, democratic, and secure form of good global money. We soon may see countries issue domestic currencies that settle with, or are even backed by, bitcoin.
This is the largest socio-economic experiment we have ever had. It is a project that is completely open-source, and boasts some of the most talented developers and engineers in the world. With bitcoin you don’t have to trust, you verify. I predict in the next 5 years everyone will have exposure to bitcoin in one way or another.
I hope this helped you gain a better understanding of Bitcoin, and are curious about more. Next I’ll cover scalability, the Lightning Network, and the future of bitcoin after the 21 million coins.
Reach out if you have any questions.
Twitter: @tavishgilmour
