The Bitcoin Standard - Book Summary

Dive into the future: A captivating exploration of finance's evolving landscape

From the physical money in our piggy banks to the globally recognized credit cards tucked into our wallets, the lifeblood of our society is fundamentally linked to finance. Imagine reverting to the barter systems of our distant forebears—trading corn for clothing and livestock for lamps—sure, it works on a community scale, but can it drive the global commerce machine? Absolutely not!

The key lies in establishing something that everyone deems acceptable and reliable. In the recent past, we found this in the form of paper currency underpinned by the worth of gold. A seemingly uncomplicated yet highly effective concept — after all, what better tangible assurance of wealth preservation than a shiny metal nugget? This sparked an era characterized by unparalleled growth and prosperity. Alas, when governments decided to abandon the so-called "gold standard" and took to mass printing money in the early twentieth century, we were plunged into a century marred by economic instability, frenzied ups and downs, and mounting debt.

But let's not rush back to stocking up gold coins just yet. The dawn of the digital age heralds a new player: Bitcoin. Echoing gold's stability and value storage, and boasting the convenience of anytime, anywhere usage, Bitcoin presents itself as a potential savior. If it can successfully navigate the initial hurdles, Bitcoin may well be our ticket to a new era of growth, reshaping the standard for our digitized world.

In the sections ahead, prepare to unearth:

- How the advent of advanced technology signed the death warrant for an ancient rock-based currency,

- The dangerous precedent set by governments since Caesar's time, leveraging currency devaluation to bankroll their wars, and

- The compelling case for Bitcoin as the new-age, digital standard.

Unraveling the origins of monetary exchanges

Ponder a world sans currency. It sounds unlikely, doesn't it? Yet, such a world existed, operating on a system of barter or direct exchange. It's a fairly straightforward notion – swap two pigs for a cow, or perhaps a sack of grains for a pottery set. It simply hinges on what you possess and what the other party desires. But what happens when these interests don't overlap? Unfortunately, you're stuck with what you've got. But money offers a way around this limitation. It acts as a universal desirable entity, capable of mediating any transaction, a system better known as indirect exchange.

But don't imagine ancient coins or crisp bills. Primitive currencies took on wildly different forms.

Consider the residents of Yap Island, part of the Federated States of Micronesia. Until the late nineteenth century, their currency was peculiar "Rai stones". These stones, varying widely in size, with the largest tipping the scales at a whopping four tons! Newly minted stones were hauled atop a hill, visible to the entire populace. The owner could then trade ownership or a portion of the stone for goods or services. Every transaction was a public affair, voiced to all islanders, and recorded in collective memory.

The system functioned effectively due to the salability of the stones. The inhabitants knew that owning a Rai stone essentially meant possessing a sellable asset. Added perks included their wide acceptability throughout the island, thanks to their visibility, and divisibility, making them flexible for transactions of different values, be it a basket of fruits or a sturdy raft.

So, if these stones were such a success, why aren't they in use anymore? The answer lies in their value depreciation over time or loss of salability. Initially, the strenuous quarrying process on adjacent islands naturally limited the supply of stones, helping maintain their value. But everything took a turn when Irish-American captain David O'Keefe, shipwrecked on the island, began importing a large number of these Rai stones using advanced technology, trading them for coconuts. The sudden influx of stones led to a drop in their rarity and consequently, their value. They were reduced to mere decorative items, ceasing to serve as an effective form of money.

Paving the way for durable money: the golden era

The money we now carry around didn't spring into existence out of the blue. It evolved from a transformative technology developed in ancient pre-Christian societies: metallurgy—the art of refining metals. This technology paved the way for producing highly marketable coins that were compact and light enough to facilitate cross-regional trades.

In this realm of coinage, one metal reigned supreme: Gold. Why gold, you might ask? It possesses a few distinctive attributes. Firstly, it's practically indestructible and cannot be artificially created. Secondly, locating gold is no easy feat. It requires delving deep into the earth's crust. Adding to this, as we extract more gold, the further we need to mine for the next trove, which keeps the growth of gold supply slow and predictable despite technological advancements in mining.

These qualities combined make gold an exceptional store of value, enhancing its marketability across time. This fact didn't go unnoticed. As far back as 2,500 years ago, King Croesus of Greece was minting gold coins!

The courtship between money and gold truly flourished during the eighteenth, nineteenth, and twentieth centuries, a period that marks the age of sound money. To better comprehend this term, let's revisit the historical backdrop.

These centuries were characterized by swift advancements in communication and transportation technologies. Innovations like the telegraph and railroads drastically simplified the movement of people and goods. This facilitated the increasing usage of highly convenient, intangible forms of payment such as checks, paper receipts, and bills. But a pivotal question emerged: How could merchants and consumers be convinced that these paper forms of payment held tangible value?

The solution propagated by governments worldwide was to introduce paper money backed by precious metals stored securely in vaults. Gold became the metal of choice in the leading European nations. Britain spearheaded this trend, with Sir Isaac Newton — serving as the Warden of the Royal Mint — introducing the "gold standard" in 1717. By the turn of the twentieth century, approximately 50 countries had embraced this standard. As a result, gold's marketability and value amplified due to the burgeoning issuance of paper currencies pegged to gold reserves. This marked the era of sound money: the markets had independently crowned gold as the most reliable store of value, and thus, money was now securely backed by it.

Manipulating monetary value: funding wars through currency devaluation

Picture the first century CE. The Roman emperor Julius Caesar introduces the "aureus," a coin containing approximately eight grams of gold, which soon becomes the standard form of payment across the vast Roman Empire. But as the Empire's growth decelerates, rulers resort to a cunning strategy known as "coin clipping," where they discreetly reduce the precious metal content in the coins to augment their expenditure capacity. Sounds like a clever plan, right? Well, not so fast! Over time, this practice precipitated inflationary pressures and triggered a succession of economic crises, signaling the decline of the once invincible Roman Empire!

The gold standard, however, wasn't flawless. Gold reserves were stored in a select few bank vaults to facilitate the swapping of paper money for gold. But this resulted in a highly centralized system, granting governments the authority to manipulate the value of paper currency. They could theoretically increase the money supply without augmenting the gold reserves proportionately. Thus, the marketability of paper money was entirely under their control.

A testament to this occurred in 1914 when war stirred across Europe, and nations needed funds for their militaristic pursuits. Instead of hiking taxes, they took a leaf out of the Romans' book and opted to print additional money. But there was a catch: this new money wasn't supported by corresponding gold reserves. As nations plunged into the First World War, the conversion of paper money into gold was rapidly suspended across the board, leaving the gold standard in disarray.

This move had two significant impacts. Firstly, it provided a readily available cash supply to fuel war expenditures for four more gruesome years. Secondly, this explosion of unbacked money led to a severe depreciation of existing currencies. Take the Austro-Hungarian krone, for instance, which plummeted by 68.9 percent against the Swiss franc, a currency that managed to retain its tie to the gold standard due to Switzerland's neutrality during the war. Both these repercussions profoundly shaped the postwar economic landscape in Europe.

From gold to government: the era of fiat currencies post World War I

The close of the First World War in 1918 left the participating European powers grappling with the complex task of revamping their currencies. Reverting to the gold standard might seem like the straightforward solution, but an equitable revaluation against gold would have exposed the stark depreciation of their currencies—a bitter pill for public consumption.

Resurrecting the former exchange rates was equally unfeasible, as it would inflate the value of paper money unrealistically. This would trigger a surge of citizens seeking to convert their paper receipts into gold, which they could then lucratively sell abroad.

So the governments opted for a more convenient route: the introduction of fiat money. Fiat money, backed by governmental decree rather than gold, triggered an era of unsound money marked by escalating state intervention to stabilize currency values.

As the conclusion of the Second World War drew near in 1944, the victors began structuring the postwar economic framework, known as the Bretton Woods system, named after the New Hampshire hamlet where the agreement was signed. The crux of this scheme was pegging all global currencies to the US dollar at a fixed exchange rate, which would, in turn, be linked to the value of gold at a fixed rate. The newly established International Monetary Fund—IMF—assumed the responsibility of enforcing these exchange rates. Strikingly, this entire structure hinged on relocating all participating countries' gold reserves to the United States!

On paper, Bretton Woods echoed the pre-1914 gold standard, as all currencies could, in theory, be exchanged for gold. In reality, the system didn't play out as envisioned. The United States stretched the rules, inflating its currency relative to gold, while other nations inflated their currencies against the dollar to propel economic growth. Eventually, gold was discarded entirely as the standard for currency. It was impracticable to tether an inflating currency to gold. On August 15, 1971, President Nixon declared that dollars would no longer be exchangeable for gold. From then on, the value of currencies would be determined by the open interplay of the world's major fiat currencies. As we'll delve into in the following part, this move would have calamitous consequences.

The recipe for prosperity: the case for sound money

The zenith of sound money was witnessed in the 19th century, with paper money standing firmly backed by gold, a precious metal embraced by the free market for its remarkable attributes as a reliable store of value. This laid the foundations for a prosperous era. Let's delve deeper into how it functioned.

The primary allure of sound money is its power to incentivize savings and investments, sparking sustainable, long-term economic growth. You see, humans have a strong positive time preference—we are inherently wired to desire immediate satisfaction over future contentment. Sound money nudges us towards contemplating more about the future, given that the expectation of our money's worth appreciating over time steers us towards maximizing our future earnings.

And that's precisely the essence of investment—deferring immediate gratification in anticipation of enhanced future gains. Investment paves the way for capital accumulation. Funds are funneled into the production of capital goods—goods utilized to generate other commodities and future revenue streams. The greater the extent of capital accumulation, the higher the possibility of steady, long-term economic growth.

The downside with unsound money is that it muddles capital accumulation. When governments meddle with the money supply—through actions such as tweaking interest rates—they inadvertently tamper with prices. This is problematic because prices serve as the vital compass guiding investors to make informed decisions without having to track every minute global occurrence. For instance, if a businesswoman in Malaysia chooses not to expand her office due to a sudden surge in the cost of copper wiring, she doesn't need to be aware that an earthquake in Chile caused this price hike. The price alone provides her with the necessary insight. However, governmental intervention disrupts this mechanism, preventing prices from accurately mirroring market trends, thereby distorting capital accumulation.

On shaky ground: the repercussions of unsound money

Unsound monetary policies, such as those adopted by European governments during the First World War, set the stage for myriad problems. Two glaring concerns stand out: recessions and perpetual debt accumulation. Let's explore these further.

Let's talk about recessions first. Government interventions often manifest as centralized planning. The crux of the problem lies in the fact that no individual, agency, or department can fully grasp the sprawling, dynamic matrix of preferences, choices, costs, and resources that constitute an economy. A lack of this complete understanding invariably leads to misguided decisions, and that's precisely what governments end up doing when they tinker with the money supply. Such meddlings distort markets, particularly capital markets, triggering a "boom and bust" cycle. During an upswing, artificial money inflation deludes investors into believing they can afford more capital than their actual capacity. The ensuing boom soon swells into a bubble; when it bursts, a recession inevitably follows.

Next, let's delve into debt. To understand how unsound money propels economies towards debt, let's cast our minds back to the Great Depression of the 1930s. Governments progressively favored policies championed by British economist John Maynard Keynes during this era. According to Keynes and his disciples, the "Keynesians," recessions are a product of inadequate total expenditure in an economy. The optimal response to recessions, they argued, was to ramp up spending.

But how do you achieve that? One way could be to cut taxes, but people rarely spend the additional money they retain. The only other alternative is for the government to foot the bill for all the additional spending. As tax hikes during a recession are challenging, governments inevitably opt to expand the money supply. This has rippling effects on spending habits. Remember the concept of time preference from the previous part? The surge of cash circulating in the economy often nudges people to prioritize the present. Saving loses its appeal, paving the way for a culture of hasty and imprudent investments. Soon enough, people find themselves drowning in debt.

This sets the stage for an unending crisis. Government intervention triggers recessions and the Keynesian response merely worsens the situation. However, an alternative exists. We need to steer our way back to sound money and a revived gold standard. The emerging technology of Bitcoin might just be the beacon guiding us towards that.

The secret sauce of Bitcoin: its inherent scarcity

After years of unrestrained spending and mounting debt, it's high time for governments to make a U-turn and revisit sound money policies. This is where Bitcoin steps in. But how exactly can this pioneer digital currency guide economies towards recovery, stability, and growth?

Cast your mind back to the gold standard. Markets selected gold as a value storage medium for two main reasons: its scarcity and predictability, implying that there’s negligible risk of its supply surging enough to significantly erode its value. Bitcoin shares these features. In fact, its supply is literally capped. No matter the circumstances, the total number of bitcoins will never exceed 21,000,000. Once that figure is fully in circulation, no more bitcoins will be minted.

The creation process of bitcoins also contributes to stability, as the currency supply grows at a consistently reducing rate. Here's how that unfolds. Similar to gold, bitcoins are mined. Computers networked across the Bitcoin system pool their processing capabilities to solve intricate algorithmic problems to unearth new coins. Once these riddles are solved, the "miners"—the computers instrumental in cracking the puzzles—are rewarded with bitcoins. To avert digital gold rushes, Bitcoin's architect, Satoshi Nakamoto, incorporated a built-in safeguard—the number of bitcoins minted is halved every four years. The cherry on top? The algorithmic problems become increasingly challenging to solve as more computers join the solving process, ensuring a steady and dependable supply, mirroring the ever-increasing difficulty in mining gold that maintains gold supply stability. Bitcoin will persistently be issued in decreasing quantities until 2140, post which no more coins will be released.

This sets bitcoins apart. They are the sole commodity characterized by absolute scarcity. Contrast this with traditional resources like oil and gas. We perceive them as scarce, but we also know that if we are ready to invest the required resources, we will likely uncover new reserves. Despite our escalating consumption of oil, total confirmed oil reserves worldwide are actually increasing! Bitcoin is a stark contrast. No amount of time or resources can generate more coins than the algorithmically dictated supply limit. The takeaway is that bitcoin's value can never be diluted by tampering with the supply, rendering it an ideal store of value.

Standing firm: The unparalleled security of Bitcoin

Sound money doesn't solely hinge on the scarcity of the medium storing its value. It also requires robust security. After all, if you're uncertain about the safety of your bitcoins, you'd naturally seek alternatives. Fortunately, this digital currency boasts remarkable security features.

The credit for this goes to the Bitcoin ledger, which employs a groundbreaking technology known as the public blockchain. So, what's the deal with that? When mining computers crack an algorithmic puzzle, they generate a block. This block is essentially a comprehensive log of recent transactions and mining activities. Each block is appended to a chain of preceding blocks, resulting in the Bitcoin blockchain. This ledger meticulously records every minutiae of each blockchain transaction ever completed. Here's the fascinating part: this entire data trove is accessible to all network users. Bitcoin ownership is only legitimized once it's cataloged on the blockchain, and this is possible only if a majority of network users endorse it.

This means that the Bitcoin network is entirely self-sufficient; it doesn't rely on any central authority to supervise transactions. From a security standpoint, this is more crucial as it makes transaction verification more straightforward than deceit. Would-be fraudsters would need to invest a significant chunk of processing power to fabricate a fraudulent block—and, courtesy of Nakamoto's difficulty adjustment, this will become even more challenging as Bitcoin gains traction. In stark contrast, new block verification demands almost no energy. A majority of nodes can flatly reject a dubious block without exhausting any significant processing power.

It's a remarkably effective safety valve as it heavily skews the balance against cheats. Even if a user managed to expend enormous amounts of energy and successfully manipulated a majority of all network nodes to approve a fraudulent block, they'd benefit very little. Breaking through Bitcoin's security would rapidly erode trust in the network, sparking a decline in demand and value. That's tantamount to shooting oneself in the foot!

A new standard in Bitcoin? Brace for some challenges.

We're aware that Bitcoin is both scarce and secure, but is that sufficient to ensure its enduring relevance? The response rests on how proficiently it can navigate a couple of significant obstacles.

Consider price volatility, for instance. When bitcoins were initially used to conclude a transaction in May 2010, one coin was priced at $0.000994 US dollars. Fast forward to October 2017 and that figure skyrocketed to $4,200 — a staggering upsurge of 422,520,000 percent! And that only illustrates long-term volatility. In 2017 alone, a single bitcoin's worth leaped from $750 to $20,000. These fluctuations primarily result from demand dynamics. With a rigid supply of bitcoins, price changes are the sole means for the currency to react to shifting demand. Since Bitcoin is a nascent player, demand has naturally experienced severe fluctuations. The downside, however, is the undermining of the currency's reputation as an effective value storehouse. Could we expect more stability in the future? According to the author, these fluctuations should stabilize as the market expands.

This segues us into the second challenge confronting Bitcoin. For the currency to evolve into a new standard, it needs to grow; but even for Bitcoin, growth would inevitably hinge on a greater dependency on large, centralized institutions. This poses a problem when a currency aims to offer an exchange platform that is independent of government-sanctioned intermediaries like banks!

Regrettably, there doesn't appear to be a solution to this conundrum. At present, Bitcoin's transaction limit is pegged at 500,000 per day. Although this limit can be increased, the reality of a daily cap can't be circumvented. Coupled with this is the cost factor. The more transactions executed, the higher the need for nodes. This increases the number of Bitcoin ledger copies requiring updates, pushing up both transaction fees and processing power consumption. Putting these facts together, it becomes clear that taking Bitcoin trade off the blockchain—in other words, dealing in currencies backed by Bitcoin—seems like a compelling proposition. This could pave the way for a new standard, but it also implies that centralized institutions would need to be established to manage this system.

Bitcoin could potentially lay the groundwork for introducing a modern sound-money policy. However, a question looms over its future: Can it evade the fate that befell the gold standard? Only time holds the answer.

A brief wrap-up

The central message of this narrative:

Over the centuries, money has taken on various forms and sizes, but only one system has truly stood the test of time: money backed by gold. This "gold standard" underpinned an era of prosperity and stability. However, the dawn of the twentieth century marked a turning point when European governments renounced gold and fiscal caution to bankroll their wartime efforts. The consequences continue to echo in our world characterized by growing debt and cyclical booms and busts. It's clearly time for a paradigm shift, and Bitcoin could potentially lead the way. It mirrors gold in being an effective exchange unit. However, for it to usher in a new era of sound money, the digital currency has to successfully address some initial hiccups.