Chapter 1: The Bitcoin Supply Dilemma
Store of Value or Medium of Exchange?
"There is nobody to act as central bank to adjust the bitcoin money supply as the population of users grows. ... I don't know a way ..."
About a year ago, after publicly announcing the Bitcredit Protocol proposal, I was confronted with criticism from unexpected quarters. Until then, I was prepared for pushback from statist and collectivist circles. For the political class, fiat money printing by monopolistic central banks enables desirable big spending by big government which they idealise.
But two critics from the Bitcoin community made me uneasy. Both were educated, polite and had thought deeply about Bitcoin. They were free market minded, certainly not collectivists. One of them had authored a book about cryptocurrencies, the other was a board member of the Bitcoin Austria association. When these two expressed scepticism about the project combined with a genuine desire to understand it better, I thought that it should be easy to dispel their objections and win them over.
So I met the author in Cafe Stein, a coffee house close to Vienna University. He shared that he was a former banker and now CFO of the Austrian subsidiary of a large corporation. I told him that I started out as a commercial banker with Citibank, moving on to investment banking, and later founded an online bank; how I had first learned about Bitcoin when curiosity led me to the ‘$100 Party’ at Noc Noc Bar in San Francisco’s Lower Haight district in 2013.1
“Then, during the 2015 Greek Debt Crisis,” I told him, “I realised that a key part of Bitcoin was still missing and until then, our hopes for Bitcoin were in vain.”
“What was that?”
“Well, the idea was that Bitcoin would replace today’s fiat money system. That it would catch on during a currency crisis and save entire countries from economic collapse. But the Greek people could not switch to Bitcoin.”
Realising that my vis-a-vis was still young at the time, I filled him in on how the European Central Bank cut Greece from the Euro liquidity supply after a democratic referendum rejected the ECB’s austerity plan for a bailout with a 61 percent ‘No’ vote versus 39 percent ‘Yes’.2
“Essentially, ECB leadership took the Greek people hostage.” I explained how its then president, Mario Draghi, backed the country into a corner using ECB’s monopoly power over the Euro. Without an alternative money supply, the Greek banks had to close for three weeks. The economic impact for daily life and for the overall economy was severe. Companies could not pay their employees, suppliers, or bills.
Cash machine withdrawals were limited to a small daily amount. Desperate people waited in long lines and often found the machines empty when it was their turn. Many families could not buy daily food or even necessary medication, as retail businesses and pharmacies asked for cash only.
In the end, Greek Prime Minister Alexis Tsipras caved in and signed the EU’s bailout conditions, with some slight modifications so the referendum on the prior version would not apply. Recovery took a long time, the Greek economy experienced slow growth in the following years and unemployment remained high.
“Despite this desperate situation, Greece could not switch to Bitcoin. One cannot buy Bitcoin when one has no access to one’s bank account. The fiat on-ramp is shut.”
“But,” he objected, shaking his head, “this is irrelevant. Bitcoin turned out to be a store of value, not a medium of exchange. It is an inflation hedge!”
“Not necessarily,” I contradicted, “we can still turn it into a medium of exchange if we build the elastic Bitcoin supply which is needed for trade and industry.”
“Bitcoin holders will never agree to an elastic supply. It is the fixed supply which will increase the value of Bitcoin forever, to millions of dollars.”
I pleaded the bigger picture. “Bitcoin must become a medium of exchange, or it cannot succeed when a fiat system collapses or spins into hyperinflation. This could prevent enormous human suffering and despair like in the 1920’s Weimar Republic or in countries with broken money like Lebanon and Zimbabwe.”
“It is everybody’s own free choice to buy Bitcoin or not. Those who do will be protected against a bank crisis and against inflationary money printing.”
That was the moment when I got a sense that our debate would need more than one cup of coffee. The statement about ‘everybody’s free choice’ was true. But it also was not, as it assumed implicitly that things would stay as they are.
I neither think that Bitcoin will remain a store of value for long if it does not become a medium of exchange reasonably soon, because some other digital currency will then be ‘it’. I will elaborate in a later chapter. Nor do I believe that nominal riches in a fiat currency will buy much when the real economy collapses in a hyperinflation or in the event of a banking system breakdown. And finally, the fiat money system and its intrinsic ideology are threatening our free open society far beyond just inflation. Central bank digital currencies are looming on the horizon. If politicians succeed in imposing them, CBDCs will give unprecedented powers of surveillance and political censorship to the state machine, in authoritarian countries just as much as in the free world. We need to fix our money and we do not have much time left.
So how could I respond? A common ground is that bitcoiners agree on the ills of today’s fiat money systems. We are highly critical of governments printing money out of thin air to fund deficits. We dislike that this enables the politicians in power to waste resources and bloat the state. We think of fiat money printing as clandestine thievery from the working people who struggle and toil and still cannot get ahead. We know that the interest rate manipulations of the central planners at central banks cause boom and bust cycles which result in economic instability. The former create bouts of labour shortage, the latter painful unemployment. Inequality rises through wage growth disparity to the detriment of lower income workers. Young people entering the job market find it hard to secure work during a recession, leading to youth unemployment. Artificially low interest rates cause price bubbles in the stock market which favour the well-to-do and the already wealthy, and increasingly unaffordable house prices make it virtually impossible for the average young person to enter the housing market.
“Don’t you also want these problems fixed and gone?” I asked, “A better world? We can only make this happen if we get rid of the fiat system, and for this Bitcoin must become a viable money for the real economy. That’s why it needs an elastic supply.”
“Not so. This would need a central bank and we know how that ends. It is better to have a fixed supply. You can’t change Bitcoin Core, anyway.”
“This needs neither a central bank nor a change to Bitcoin Core,” I countered, “the new protocol is a separate new layer. It is decentralised and will stabilise Bitcoin and eliminate its volatility.”
“Volatility will abate in time, all by itself. Meanwhile I am insured against fiat money inflation by hodling Bitcoin.”3
I wanted to explain that this is not how it works but realised that this would need a much longer explanation, maybe a whole book. So we left it at that and headed off. I slept uneasy that night as I considered our conversation and wondered if and how I could have convinced my acquaintance.
The essence of his argument was simple: just wait and it will fix itself. This was a very convenient stance, it removed the strenuous need to act. On the surface it was also an accurate statement, given the current state of Bitcoin. It was that seeming truth which bothered me because I know that in economic matters things can and will change.
I had lived through the internet bubble in 2000 to 2001 when everybody talked about how the internet would change everything and that it was the dawn of an entirely new economy, a New Economy in capital letters, where the old rules were meaningless and the sky was the limit. Prices of internet company shares seemed to know only one direction: up. Media and markets were in a frenzy, every new stock with a ‘.com’ appended sold like hot bread rolls. But all parties must end, and the dot-com bubble ultimately did burst with losses reaching hundreds of billions of dollars. Millions of investors lost their money and many faced financial ruin.
Today’s crypto asset industry shares many similarities with the internet bubble. There is the same speculative frenzy, just now called ‘FOMO’, the Fear Of Missing Out on ‘NGU’, Numbers Go Up. There is the same media hype and the same boundless excitement over a revolutionary new technology with a huge but yet unknown impact. Sadly, there are also the sharp crashes and significant financial losses for crypto investors who got ‘rekt’.
So far, Bitcoin was always able to recover from its crashes which evidences its plausible candidacy as our future global money. Maintaining the fixed supply model promises rich capital gains to those already invested. But there are certain events which could change this very quickly, there is no safety or certainty in its unfinished state.
This raises two questions: Firstly, are these promises real, and how many holders of Bitcoin – in its current state – will ultimately benefit, how many will be late, miss the short peak and lose out? Secondly – and this is the deeper question – shall Bitcoin remain an investment asset for the few or should it become a better money that serves the many?
An elastic Bitcoin supply is not just an economic choice, it is a moral one.
https://www.forbes.com/sites/kashmirhill/2013/05/01/living-on-bitcoin-for-a-week-the-journey-begins/
https://www.bbc.com/news/world-europe-33403665
‘Hodling’: Bitcoin talk for holding.