Bitcoin

Bitcoin Is Changing The Rules Of Money


Introduction

Many criticisms of Bitcoin (BTC-USD) (COIN) (OTCQX:GBTC) rely on the argument that Bitcoin does not fit the definition of a currency, a unit of account, or that it cannot be a store of value and a currency at the same time.

First, we will explain these arguments in detail. Then, we will explore why these claims fall short. We’ll also discuss some interesting and new properties that Bitcoin has that bring uncertainty into our existing models of money, exchange, and even accounting.

The Unit of Account Argument

What is a unit of account?

Unit by which value of a thing is accounted and compared. It is one of the primary functions of money. – Business Dictionary

Essentially, this means that accountants keep the books in terms of US dollars and we also price things in that same unit, hence unit of account. True, the dollar does inflate a bit each year, but the semi-steady clip is unlikely to catch anyone off guard (although government statistics on inflation tend to be dubious at best).

This is achieved by expanding or contracting the monetary base, tinkering with the Fed Funds Target Rate, and abusing our exorbitant privilege in having the world’s reserve currency (and if all that fails, we just deploy the largest military in the world and everything seems to work out fine).

Now, when it comes to Bitcoin, this technique will not work, because the supply is fixed (and the only army Bitcoin has is a bunch of dedicated nerds). Therefore, the critics say Bitcoin cannot act as money. When a boom or a bust comes, with no ability to control the supply, the price instead has to increase or decrease to keep the system in balance. Because the swings can be quite drastic, it’s hard to price goods and services in terms of Bitcoin.

However, I’m going to argue that Bitcoin doesn’t have to be the yardstick, because I don’t think the US dollar is going away. Things will still be priced in US dollars, but people will pay with Bitcoin because it’s a better place to store your wealth long term.

The Deflationary System Argument

Many have claimed that a deflationary monetary system is doomed to failure, because too many people will save instead of spending, which will grind the system to a halt, eventually collapsing the entire economy. Key here is the concept of the Velocity of Money.

There is one fatal flaw in this assumption, and it’s a big one.

We have to assume that only one monetary system exists!

But what is this assumption based on? In most of the world, each country has its own sovereign currency, and all other forms of money are inferior second choices; like what happens when you go to pay for the parking meter and find a Canadian quarter in your pocket.

Homer-Doh-canada

Image Source: Google Images and Author’s MS Paint Skillz

What if multiple monetary systems were to coexist? What if you could pick among many systems, with the US dollar remaining as the measuring stick?

This is happening right before our eyes. As we move towards a global cashless society, changing one currency for another will become as simple as the execution of a few lines of code. The only real barriers to having this right now are regulatory, not technical.

Today, we have Venmo, PayPal (PYPL), Square (SQ), and such. In the near future, we’ll have broad usage of decentralized, peer-to-peer, blockchain powered, layer two solutions like the Lightning Network and Plasma, and it’s going to be wild.

Mutual Exclusion of SoV and MoE Argument

If you think about stores of value, they’re notoriously hard to spend. A piece of land for instance; how are you going to “spend” that? What about gold coins? Sure, they’re valuable, but unless you’re buying something that’s exactly the same value as an ounce of gold, how would you spend that mint condition bullion? You could cut the coin up, but that sucks. What can we do?

One option would be to have a debit card backed by some store of value, like your brokerage account, or the gold you have in a vault somewhere. But that’s an inelegant solution. After all, if you spent half of a gold coin, someone has to figure out how to cash you out later on. If you spent half the value of your plot of land, how would you settle up? You’d have to take out a loan or sell the land, none of this is really optimal.

Plus, it gets even worse with other stores of value, like fine art. What are you going to do? I suppose you could shred the art up and try selling the pieces? This approach has obvious drawbacks as well.

shredded banksy

Image Source: ABC News

Bitcoin is a store of value that can act as a currency

Bitcoin is a store of value that is highly divisible, making it a much better candidate to also act as a currency. It may seem strange that something completely digital could be a store of value, but as we’ve seen, there is immense value in information. Why do you think Facebook (NASDAQ:FB) and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) are “free?” The information they gain from us is orders of magnitude more valuable than the “free” product they produce. As the amount of data we produce each day increases, the question about who should benefit from that value created needs to be raised.

Bitcoin is the first instance of digital scarcity, and it enables people to actually control a valuable and scarce digital resource. This same technology may one day enable us to take control of our own digital identity and the reams of data we’re producing in the same way. However, this is a challenging undertaking.

Bitcoin is still young and is currently going through a paradigm shift

Right now Bitcoin is a store of value that you can also spend. Here we see the issuance schedule of Bitcoin:

bitcoin supply

Image Source: En.Bitcoin.It

As the stock-to-flow ratio shifts over time, the volatility decreases.

bitcoin volatility

Image Source: Woobull

Bitcoin is transitioning into a method of exchange that also stores value; it’s evolving.

Bitcoin’s Impact on Accounting

Accounting may not seem like a “hot topic.” But without it, we could not have a modern economy. Each advance in accounting has brought about a revolution in commerce and money.

Let’s revisit the history of the ledger for a moment. One primitive form of record keeping consisted of placing special marks notches on sticks called Tally Sticks.

tally sticks

Image Source: Wikipedia

In South America, the Quipu was used to keep track of things like tax obligations and census records. This system relied on ropes of differing color with knots tied in different places as a method of encoding values.

quipu

Image Source: Wikipedia

Eventually, a system of double entry accounting was introduced and it ignited a boom of prosperity in money, finance and economic activity at large.

By the 1400s, a Franciscan friar finally codified the double-entry system and it swiftly became the standard with Venetian merchants. All thanks to the preserving power of print.

This opened up world trade. Now goods could flow easily to all the empires of the old world.

Fast forward to today and we still use a double-entry system. If you do your taxes in TurboTax or keep your books in Quickbooks you’re using double-entry. Daniel Jeffries Via Hacker Noon

The next wave of innovation is kicking off now. It’s called triple entry accounting. The idea is that each transaction must be cryptographically signed, meaning that it must arrive from a valid state in the past.

The Receipt is the Transaction. – Ian Grigg

So, what exactly could we do with triple entry accounting? How about making fraud more difficult? What about provably fair elections where your individual identity is protected, but the audit trail is available for everyone to see and verify? This is just the tip of the iceberg, and why some have called triple entry accounting the most important invention in the last 500 years.

Enter the age of hybrid thinking

We live in an age of rapid change. Some of the strangest things that have happened seemed to come out of the blue. This is because we tend to project the present into the future, but we are unaware of how overlaps between seemingly disparate industries can result in something totally new and unexpected, like social media.

We wanted flying cars, instead we got 140 characters. – Peter Thiel

If you read my article on why Ethereum (ETH-USD) matters back in June, you may also have seen this quote:

“What do you get when you mix self-driving cars, cryptocurrencies, and AI? The self-owning car!” Former Bitcoin developer Mike Hearn

But let’s back up for a minute. There are much more mundane examples of this type of technology convergence that we’re all familiar with such as the smart phone.

Think of all the things a smartphone does. It’s simultaneously a camera, telephone, text messaging device, a video recorder, a GPS, the perfect tool for spying on you, a web browser, an entertainment system, a television, an mp3 player, and a multipurpose computing system that can install millions of different applications all while providing a 4G connection in most of the developed world.

smart phone replaced

Image Source: Gecko and Fly

Holy cow. That’s a lot, and we take it for granted.

So, if every industry from photography to television, gaming and mapping can be disrupted so quickly by a device as commonplace as the smartphone is right now, why do we think that money can’t be disrupted? Why do we think that a new hybrid system couldn’t change the rules?

Bitcoin is such a system. However, it’s not a traditional money system, because:

  • It isn’t issued or controlled by a government
  • Its supply is fixed
  • It can only handle so many transactions per second (for now)
  • The price is volatile

But Bitcoin has some properties that are quite novel. Let’s explore a bit:

  • It can act as a store of value AND as a currency that’s highly divisible
  • It is distributed, with no central point of failure
  • It is a technology that’s growing very fast
  • It ignores national borders and has re-awakened the entrepreneurial spirit
  • It uses cutting-edge cryptography
  • It is fully digital, and yet still scarce (you can’t copy and paste BTC)
  • It is open source
  • It implements triple ledger (you agree, I agree, and we have a hash of the entire past as well, cryptographically signed)

So, as you can see Bitcoin doesn’t fit into any box we know of. We can’t call it a traditional currency, but it has many properties of a currency. It’s a store of value, but it can also be spent in small amounts (satoshis, or even milli-satoshis on the Lightning Network).

Because it’s a software system, it’s a money technology that’s growing and getting better at an incredible pace. As Charlie Lee would say: “How many people are coding the US dollar right now?”

Bitcoin lets people innovate on the edge, and it doesn’t exclude people. How much potential can we unlock when we dare to challenge the myths we hold about money.

Cowry shells and dollars have value only in our common imagination. Their worth is not inherent in the chemical structure of the shells and paper, or their color, or their shape. In other words, money isn’t a material reality – it is a psychological construct. – Sapiens, P. 180, Yuval Noah Harari – 2014

Conclusion

To think that money is an extrinsic and unchangeable system is just a modern intellectual dogma. After all, we live in a world largely consisting of shared human imagination.

In a recent piece on NPR, someone pointed out the way we loosely apply labels to technology. We call the computer in our pocket a phone, but really the “phone” part is just an app that the device runs. In much the same way, money is just an app that’s running on Bitcoin now, but much more is coming.

This article was first published in my marketplace Crypto Blue Chips.

Disclosure: I am/we are long BTC-USD, ETH-USD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





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