Bitcoin’s Possibilities and the Errors of Fiat Economists
Whether fiat authorities like it or not, Bitcoin is now in free market competition with many other assets for the world’s cash balances, and it is a competition Bitcoin will win or lose on the market.
by Saifedean Ammous
The following essay first appeared in Saifedean Ammous’ 2021 book, The Fiat Standard. It has been edited, truncated, and republished here with permission from the author.
Perhaps the most common misconception about Bitcoin among fiat economists is that they imagine it needs their educated official approval, and a regulatory green light, to be adopted as money. Government control of the monetary system and scientific funding has convinced generations of economists that reality is the product of fiat edict and given them a thoroughly top-down approach to understanding the world, where bureaucrats, scientists, politicians, journalists, and other positions of fiat authority are the enlightened vanguard of society who decide for the plebs how to live their lives. To this day, economists continue to engage in belabored theoretical discussions on whether Bitcoin fits their preferred definition of money, whether it is worth the energy consumption, and whether it should be allowed to continue to exist. The longer Bitcoin continues to operate, the more these concerns begin to look like the quaint superstitions of primitive tribes on first contact with modern civilization.
Bitcoin’s continued successful operation, its ability to perform final settlement internationally without requiring any government oversight, and its credibility at maintaining its monetary policy over twelve years all mean that it operates outside the realm of fiat authority (and delivers a shattering blow to the worldview of those who think reality comes out of fiat). Bitcoin does not need to convince fiat authority of its worth; it just needs to keep surviving on the free market by offering value to its users.
Bitcoin is the world’s first digitally scarce asset, and the first liquid asset with strict verifiable scarcity. It offers no yield and is therefore not held for its returns, like stocks. It is instead held for its own value, like cash, which Austrian economists explain is held because of uncertainty. In a world of no uncertainty, where all your future income and expenditures are perfectly predictable, there is no need to ever hold cash, as you can always place your money in capital markets to earn a return, to be liquidated exactly at the time in which you need them. But in the real world, with uncertainty pervading everything, people do need to hold cash balances to meet their uncertain future obligations.
Fiat’s inflationary nature has eroded its ability to play the function of cash, and as a result people have sought several substitutes to perform this role. People primarily hold government bonds as a way to recreate cash’s ability to save value for the future, as well as physical gold, real estate, and equity. Bitcoin is just another asset to be added to this list, with a major difference being that it can be accessed entirely outside the traditional fiat banking system in a permissionless manner.
Whether fiat authorities like it or not, Bitcoin is now in free market competition with many other assets for the world’s cash balances, and it is a competition Bitcoin will win or lose on the market, not by the edicts of economists, politicians, or bureaucrats. If it continues to capture a growing share of the world’s cash balances, Bitcoin will succeed.
Where Will Bitcoin Take Us?
As it stands, Bitcoin’s role as cash has a very large total addressable market. The world has around $90 trillion of broad government supply, $90 trillion of sovereign bonds, $40 trillion of corporate bonds, and $10 trillion of gold. Bitcoin can ostensibly replace all of these assets on balance sheets, which would be a total addressable market cap of $230 trillion. At the time of writing, Bitcoin’s market capitalization is around $1.2 trillion billion, or around 0.5% of its total addressable market.
More than just cash, Bitcoin can also take a share of the market capitalization of other semi-hard assets which people have resorted to using as form of saving for the future, such as stocks, which are valued at around $90 trillion, global real estate, valued at $280 trillion, and the art market, valued at several trillion dollars. While there will clearly be stocks, houses, and arts on a Bitcoin standard, their valuations are likely currently highly inflated by the need for holders to use them as a store of value, on top of their value as capital or consumer goods. As more and more holders of these assets as a store of value discover Bitcoin’s superior intertemportal salability, it will continue to acquire an increasing share of global cash balances.
Monetary status is an emergent outcome of market choice for monetary assets, and not a result of an appraisal of theoretical monetary properties by economists. Modern economists have never contemplated the possibility that free market competition could apply to money, the holiest of prerogatives for the modern fiat governments that pay their salaries. With every passing day in which it operates to the satisfaction of its millions of users, the full-time detractors and government-paid economists who are constantly attacking Bitcoin begin to sound like deranged conspiracy theorists who have very weird reasons for being obsessed with stopping happy customers from wearing a shoe brand they like.
Bitcoin has grown from nothing to around a trillion dollars of market value on global balance sheets in the space of twelve years, without a leader, without corruption, and without governments being able to stop it. In the past ten calendar years, it has achieved an average annual growth rate of 200%. If it were to experience a similar rate of growth in the future, it would overtake the $230 trillion benchmark by 2026. If it were to experience annual appreciation of ‘only’ 20% per year, a tenth of what it experienced in the last ten years, it would arrive at the $230 trillion nominal valuation by around 2050. Rather than argue with ancient textbook definitions from the pre-Bitcoin jāhiliyya, economists would do far better by trying to think in practical terms: How much can bitcoin continue to grow, what are the implications of its continued growth, and what can stop it?
The most widely held prediction about how a Bitcoin economy develops usually involves the entirety of the world economy collapsing into a heap of hyperinflationary misery similar to Venezuela today; all global currencies would collapse in value as all their holders drop them and choose to move to Bitcoin instead. Governments would collapse, banks would be destroyed, global trade supply lines would come crumbling down. The kind of imaginations reared on watching Hollywood movies can be relied on to run wild with the scenarios here. But there are several reasons to be optimistic that this may not be the case. The move to Bitcoin could instead look more like an economic upgrade which replaces manual political central bank policy with ruthlessly efficient modern automated technology, and could in retrospect be an even better deal for humanity than the replacement of horses with engines, or phone line operators with computers.
The doomsday hyperinflationary scenario assumes that demand for national currency would collapse, leading to the value of the currency collapsing, regardless of what would happen with the supply. It assumes that even if the supply of fiat money is likely to remain constant or vary only slightly, the decline in demand will lead to the value of the currency collapsing. However, hyperinflation is always and everywhere a result of the drastic increase in the money supply, and not a sudden decline in demand. Only as a result of government and central bank increases of the money supply can hyperinflation happen, as a close study of any and every modern case of hyperinflation shows.
Looking at Venezuela today, even if one lacks any knowledge about the country’s monetary policy, we can dismiss the idea that the destruction of the Bolivar is explained by a drop in demand. Venezuela “the country” is still there, its population at largely the same numbers as before the currency collapse, and it is still in need of money and demanding more of it. While there is no doubt that demand for holding the Bolivar has dropped significantly, it could not possibly have dropped to a millionth of where it was, as Venezuelans still need the currency to settle all their government-related business (an ever-growing occurrence thanks to the socialization of the economy). The only way to understand the collapse in value is as a result of the rapid increase in supply, and any reduction in demand was rather an effect, not a cause, to that currency’s value dropping. Therefore, even if Bitcoin continues to increase its share of demand for money as a percentage of government demand, government moneys could avoid hyperinflationary collapse so long as they manage to avoid spiking the rate at which they expand their money supply.
But the more important reason to think that Bitcoin makes hyperinflation unlikely is the impact that it has on the creation of money. Fiat is created by lending, while it is destroyed by loan repayment or default. By introducing an alternative monetary asset to debt instruments, Bitcoin reduces the demand for the creation of fiat-debt, and thus the creation of fiat altogether. When the value of money is constantly dropping, and interest rates are artificially low, people are incentivized to borrow instead of save, and those who want to hold savings for the future are incentivized to do so in the form of debt-based assets contingent on repayment from others, such as bonds. But when a new and completely decentralized, depoliticized, and automated hard new money enters into the economic calculations of the individual today, that individual’s relationship with credit is likely to change. With the presence of a hard money that can appreciate in value over time, people’s need for credit will likely decline. As those who move to Bitcoin witness its value appreciate, they find themselves able to pay off their debts sooner. As they become debt free with hard savings that nobody can inflate, they are likely to start living off their savings and accumulating more, rather than continuing to borrow and pay interest. Many Bitcoin holders have already gone through this process, and many have been able to pay off all their debts thanks to the appreciation of Bitcoin. When people have a healthy store of value that appreciates over time, they are less incentivized to borrow. If Bitcoin continues to grow, and as more people do this, then the demand for credit from the traditional financial system will likely decline. Perhaps more importantly, the option of holding Bitcoin on the balance sheet will reduce the incentive of individuals to lend to others, resulting in a slowdown in the creation of fiat credit, as it replaces the demand for bonds and many other credit instruments.
This all leads to a very important realization: Bitcoin does not just reduce demand for fiat money, it also reduces the incentive and mechanisms for creating new Bitcoin supply. Rather than a threat that can destroy fiat money, Bitcoin may turn out to be the neat technological solution that allows fiat to unwind peacefully. If the fiat monetary system was a house of cards, Bitcoin’s reduction of demand for fiat, and of the incentive for the creation of the fiat supply can be likened to someone skillfully and neatly unwinding the house of cards into a deck of cards by removing two cards leaning on each other at the same time: the card of fiat demand and the card of fiat supply.
If governments in advanced economies, which have done a semi-respectable job in managing their currencies over the past few decades, manage this process wisely, they would allow the credit and money contraction to happen naturally. If they try to react with inflation, they will likely witness a quick reduction in the value of their currency. The wiser among them are likely to adopt strict monetary policy, and in that case, rather than go out on a bang, the current global monetary system would just slowly and naturally get downsized into irrelevance as its currencies slowly lose their value next to Bitcoin.
Failure on the Free Market?
While Bitcoin is indeed free market money, it does not necessarily follow that it would succeed on a free market for money. The longer I think of this, the more I begin to consider the possibility that Bitcoin is a free market solution to the problem of government control over money, but it is not necessarily the money that would be chosen on a market free of government control. For as long as governments place restrictions on money, Bitcoin can thrive as a method of going around them, but if these restrictions are eased, that might deprive Bitcoin of the oxygen it needs, demand for going around monetary restrictions.
Bitcoin is a technology built and optimized for one design consideration: resisting government capture, and nothing else. Bitcoin is not optimized for user experience, convenience, or speed of use; it sacrifices all these considerations to achieve immutability and resistance to censorship. This is extremely valuable in a world in which governments restrict individuals’ monetary freedom, but how valuable is it in a world in which they do not?
The problem of Bitcoin adoption is different from the adoption of any other technology or application in that Bitcoin’s adoption involves decisions about liquidity and cash balances. People cannot just wake up one morning and decide to only deal with Bitcoin; they have obligations to pay or be paid in different currencies, and they have savings accumulated in different currencies. They want to maximize their chances of being able to pay the money that their sellers want in exchange for their goods, and to be paid the money that buyers want to pay them. An individual’s choice of medium of exchange is primarily determined by the differing liquidity pools around them, or the different degrees of salability for different moneys. An individual’s choice of money is likely to be the money that has the largest pool of liquidity, allowing the individual the largest number of trading opportunities, and providing them the best chance of exchanging their goods with the least loss of value.
Salability is also a self-reinforcing trend, as was illustrated by gold and silver in the nineteenth century. A money with larger salability will be likely to be more attractive as a store of value than a money with less salability, and that in turn will lead to the more salable money becoming even more salable, while the less salable money continues to lose its salability.
Consider for a moment the possibility that Bitcoin does indeed succeed in destroying government fiat currencies through speculative attacks. Or consider the possibility that governments move toward freer banking and a competitive monetary system, without moving to a gold standard, but by allowing individual enterprise to provide consumers with a wide variety of choices in their monetary medium. In other words, imagine a completely free market in the choice of money, and try to imagine the consequences it would have for Bitcoin.
In such a free market, individuals will choose the money which they find to be the most saleable, and most likely to be exchanged for other goods and services. As it stands, the total value of over-ground mined gold, or the global liquidity pool of gold, is around 100 times larger than the total value of mined Bitcoin, or the global liquidity pool of Bitcoin. This is a natural outcome of gold’s huge 6,000-year first-mover-advantage over Bitcoin. Gold has been produced all over the world for millennia and is an indelible part of all human cultures that have viewed it as precious. Today it continues to be held by central banks, but also, is widely used as a store of value and medium of exchange all over the world. Gold is still the dowry necessary to get married all over the world. The majority of humans own some gold, either in the form of coins, bars, or jewelry. In a situation in which alternatives collapse, people are far more likely to go back to trading in gold because of the properties that gave it its monetary role in the first place, but more importantly, perhaps, because of the very large pool of liquidity that has been accumulating over thousands of years.
The implication of this is that, for the average individual who wants to sell a good or service in a post-fiat world, the likelihood that their counterparty will have gold to pay is roughly 100 times the likelihood that they would have Bitcoin to pay. That makes each individual far more likely to want to accept gold as money than Bitcoin, and that, in turn reinforces the same trend with all other individuals.
As it stands, a free market in money is not likely to be beneficial to Bitcoin, because in the one metric that matters most, liquidity, Bitcoin is incomparable to gold. Bitcoin needs government controls and restrictions to drive demand for it. The freer the global market for money, the more likely that any monetary competition will lead to gold winning in a winner-takes-all scenario similar to how the nineteenth century competition between gold and silver unfolded. For Bitcoin to have a chance, it needs government laws and restrictions to continue to drive people to look for hard money alternatives, thus increasing its value and the size of its pool of liquidity.
Beyond liquidity, and when it comes to issues of ease of use, many Bitcoin promoters seem a little too enthusiastic in their assumptions on the ease of using Bitcoin, and how willing people are to learn them. While I entirely agree that these technical barriers will be overcome by people who need to get around government restrictions, I am not sure there is a strong enough motivation to learn them in a world where these restrictions do not exist and people can default to using gold in all its tried and tested familiarity.
The non-digital nature of gold, and its physical heft and high cost of transfer compared to Bitcoin, are not serious obstacles for gold regaining a monetary role on a free market; they are only obstacles to the extent that they allow governments to prevent a global banking system to emerge around gold. In a free market, there is no reason that the most advanced payment technology implemented over fiat money or Bitcoin could be used on top of gold. Instant digital payments with very few settlement transactions in physical gold are pretty straightforward to build from an engineering perspective.; the real barrier to their development has always been political. In a world in which government restrictions on money disappear, the development of a gold-based financial infrastructure is likely to be faster and more advanced than a Bitcoin-based financial infrastructure, because of the larger liquidity of gold attracting more development and investment.
Ironically, it appears that Bitcoin is dependent on the governments it was built to counter for its survival. A world without government abuse of money is a world in which Bitcoin is superfluous, and monetary tradition and history will likely move us back to a gold-based monetary standard. For Bitcoin to continue to succeed and grow, it requires governments to continue to follow bad monetary policies that drive people to hold more Bitcoin, raising its price, increasing the pool of liquidity, making it more likely for others to join this pool of liquidity.
The longer that bad government monetary policy continues, the more liquidity Bitcoin is likely to amass, the closer it gets to gold’s liquidity, and the better its chances of unseating gold as humanity’s prime money in a free market. The more governments reform their monetary policies and allow their citizens financial freedom, the less demand there is for Bitcoin, and the less likely Bitcoin’s network is to grow.
Bitcoin’s survival and success is more likely in the scenarios in which the world’s central banks’ policies are similar to those that have prevailed over the past few decades, not much worse or better. Improvements in central banks’ monetary policies, lower inflation and fewer business cycles would likely reduce demand for Bitcoin. A severe worsening of monetary policy which would lead to more widespread collapse of national currencies could also jeopardize Bitcoin if it results in more free market competition between monetary alternatives without government intervention, at a time when Bitcoin still has very little global liquidity.
The good news for Bitcoin is that the most likely courses of action for governments for the foreseeable future are in its favor. The bad news for Bitcoin is that, by being built to resist government control, it is inevitably and inextricably affected by how governments behave, and might in fact be reliant on their monetary policies not improving or deteriorating too much for its survival.