Bitcoin Investing
Is Bitcoin Sound Money, and Why Should You Care?
Why Enthusiasts Claim Bitcoin Has Intrinsic Value
This is one of three articles on bitcoin investing, and it provides background for the main article, “Is Bitcoin Immutable and Safe, or Fragile and Risky?”
Bitcoin’s sound money narrative is causing many bitcoiners to study the theory of money and learn what has caused currencies to rise and fall throughout history. The precarious position of the global economy also fuels this interest. Let’s see why and how bitcoin has won over some sound money investors that previously trusted only gold to fulfill this role.
What Is Money?
Money is a commodity accepted by general consent as a medium of economic exchange. As currency, it circulates anonymously from person to person and country to country, thus facilitating trade. It is also the medium in which prices are expressed. And it is the principal measure and store of wealth. Today, the main form of money is “fiat currency,” or paper money issued by governments. Precious metals like gold were used as money for millennia. Each has their place. While government-issued coins and bills are easy to use, gold is scarce and indestructible.
While gold is no longer used as a medium of exchange, it is trustworthy enough to be considered as sound or hard money. The argument goes that hard money is a better store of wealth than fiat currency, which has boundless supply and requires trust in the government that backs it. When governments create too much paper money, inflation erodes its buying power and reduces trust. This is why investors concerned about inflation look to gold as an inflation hedge (even though its recent track record during periods of high inflation is mixed).
Let’s look at how bitcoin stacks up against the three criteria that best define money: a store of wealth, medium of exchange, and unit of account.
Bitcoin as a Store of Wealth
Despite its volatile price behavior, Bitcoin enthusiasts still argue that it is a better store of wealth than gold. All the gold bullion safeguarded in vaults around the world is worth about $5 trillion today. Astoundingly, the market value of bitcoin now hovers close to one-fifth of this amount. Will bitcoin ever muscle out gold as a hard money asset? And why all this sudden interest in these types of assets?
In the 2008 bitcoin whitepaper, Satoshi clearly conceived bitcoin as a digital form of hard money. Like gold, the strength and immutability of the bitcoin blockchain makes it indestructible. Satoshi’s code also created digital scarcity similar to gold, by limiting the total supply of coins which can ever be mined to 21 million. In the whitepaper, Satoshi wrote that this limit makes bitcoin “completely inflation free.”
Today’s fragile economic climate is a big reason why individuals and institutions are concerned about inflation and the money supply and have embraced bitcoin’s store of wealth narrative. The global economy faces conditions that have not been seen since the 1940s. These include enormous government deficit spending, record high debt levels, and aggressive government actions aimed at keeping excessive debt from blowing everything up.
These government actions became more extreme as debt levels soared ever higher through the 2007 Great Financial Crisis and the 2019 pandemic. In response, central banks in developed economies forced down interest rates to ease debt servicing costs and spur growth. U.S. interest rates are now so low that government bonds yields are negative in inflation-adjusted terms.
But that’s not all. Central banks also sprang into action by stimulating demand for bonds, and especially U.S. debt obligations. They did this by purchasing bonds on the open market, mostly off of bank balance sheets (a monetary policy called quantitative easing which was first used during the Great Depression of the 1930s). Since 2008, the world’s four largest central banks have purchased a whopping $25 trillion in government debt from banks, to prop up bond prices and encourage banks to grow their lending.
Interest rate repression and quantitative easing are now the main drivers of asset prices, pumping up the prices of everything from government bonds to stocks to real estate. These ever-inflating asset bubbles widen the wealth gap between investors and everyone else — one reason why there’s an upswing in social unrest and populist political urges.
Here in the U.S., many believe that Federal Reserve is running out of options for keeping the debt cycle going. After all, interest rates are near zero, and plentiful bank reserves created by quantitative easing are not leading to increased lending.
Thanks to all this central bank stimulus, plus pandemic-driven supply chain woes and global energy supply woes, inflation is now biting consumers. In response, central banks are easing off the accelerator a little, letting inflation run just hot enough to gradually reduce the real value of government debt. But it is very difficult to keep inflation in check once it revs up, and the political ramifications are difficult to stomach.
In a sign that lenders are losing trust in the U.S. dollar and the creditworthiness of the U.S. government, foreign holdings of U.S. dollar reserves have been drifting lower for years. And China has been shifting away from buying oil in U.S. dollars, forcing trading partners to use the yuan in an effort to displace the U.S. dollar from its traditional role as the currency of the global oil market. Billionaire investor Stanley Druckenmiller recently co-wrote a piece in The Wall Street Journal warning that, “Even after trillions spent to prop up the bond market, foreigners have continued to be net sellers [of U.S. debt]…[casting] doubts about the soundness of [the Fed’s] policies.”
Famous hedge fund founder Ray Dalio warns that we are in the late stages of a worrying long-term debt cycle that began as the borrow-and-spend baby boomers poured into the workforce in 1970s, as the chart below suggests. The problem is a global one. Right now, developing countries are being crushed by debt servicing costs which have doubled since 2010, and 54 countries are judged to be unable to provide necessary services to their citizens as a result.
When government debt reaches unsustainable levels, Dalio’s research shows that the cycle can sometimes end with a soft landing if government policymakers manage to spread out the pain (he calls this a “beautiful deleveraging”). But more commonly, long-term cycles end violently, as holders of government debt suddenly lose faith, dump their bonds, and destroy the creditworthiness of the issuers.
The ramifications of a debt cycle unwinding depend on the choices government policymakers make once the bubble bursts. When a government enacts austerity measures to reign in their spending and permits debt defaults and write-downs, the cycle ends in a disinflationary contraction. Instead, if a government continues to prop up the economy through even more fiscal and monetary stimulus, and increases taxes to reduce their deficits, this lowers debt levels by bringing about significant inflation. Dalio, who predicted the 2008 Great Financial Crisis, worries that we might be headed toward a nightmare scenario that is a conjunction of inflation, populism, and possibly even war.
While it has not been around long enough know for sure, many bitcoin proponents assert that bitcoin has intrinsic value as a hedge against economic instability, wherever it happens in the world. Enthusiasts that believe this debt cycle will end in a violent, inflationary shock see bitcoin as the only way to effectively “de-financialize” the world economy. Global macro strategist and bitcoin proponent Lyn Alden says that bitcoin “is a…way to hold something that has intrinsic scarcity, compared to something that is…not scarce for which the yields are no longer keeping up with inflation.”
Especially among bitcoin enthusiasts with libertarian leanings, some believe that bitcoin will hold its value better then gold during such a calamity, as it is more resistant to emergency government prohibitions against asset transfers or even asset confiscations (more on this in the companion article, Is Bitcoin Immutable and Safe, or Fragile and Risky?). Marc Cuban, the Dallas Mavericks’ billionaire owner, disagrees. He told a reporter that, “No matter how much [bitcoin] fans pretend that it’s a hedge against doomsday scenarios, it is not. Countries will take steps to protect their currencies [because this affects] their ability to tax.”
Cuban makes an interesting point. If Dalio is correct and the global debt bubble bursts, some currencies will be hurt more than others. Crypto usage is spiking in nations with the most fragile economies, such as Lebanon, Turkey and Venezuela. For instance, Venezuela is experiencing doomsday levels of hyperinflation. If you lived in Caracas, why would you use your already weakened bolivar to buy bitcoin? Why not just exchange bolivar for a stronger currency? Or Gold? In the midst of a crisis, perhaps bitcoin’s allure has less to do with hedging against further devaluation than in evading asset seizure or taxation from a reeling government. If so, bitcoin’s “value” would be as an anonymous hiding place, not an innocent store of wealth.
Of course, any store of wealth asset has to be exchangeable for a currency that can be used in real-world transactions. Gold is readily convertible into paper money almost everywhere — a big reason it retains trust as a store of wealth. Bitcoin’s convertibility into paper money mostly depends on centralized crypto exchanges, which, due to their centralization, present risks which are covered in my bitcoin risks article (Is Bitcoin Immutable and Safe, or Fragile and Risky?). So here is the next question: can bitcoin serve directly as a medium of exchange? Let’s take a look.
Bitcoin as a Medium of Exchange
Bitcoin’s utility as a medium of exchange is most evident in countries with weak currencies and banking systems. Bitcoin can be sent to anyone anywhere, as long the recipient has access to a cryptocurrency wallet or custodial account. Bitcoin enthusiasts extoll its ability to bring finance to the unbanked, especially in developing nations with unstable, untrusted government institutions, and as a low-cost vehicle for overseas remittances.
As a remittance currency, bitcoin’s utility is real and increasing. In fact, Vietnam, India, Pakistan, Ukraine, Kenya and Nigeria boast the highest crypto adoption rates in the world. In Afghanistan, cryptocurrency remittances have been a lifeline, as Western Union ceased operations after the U.S. pulled out, and banks have severely limited cash withdrawals. And El Salvador recently became the first nation to adopt bitcoin as legal tender, with other Central American countries rumored to be fast followers and Russia making noise it will do the same.
The Bitcoin Network is energy intensive and there’s some lag time for a transaction to be validated, verified and confirmed. To speed up transactions and reduce their cost, services such as the Lightning Network have sprung up. Lightning sits on top of and interacts with the bitcoin blockchain. Since Lightning and other similar services make it easier to buy goods and services directly with bitcoin, they strengthen bitcoin’s utility as medium of exchange.
Bitcoin as a Unit of Account for Expressing Prices
Compared to the first two criteria, it’s harder to see goods and services being priced in bitcoin rather than local currencies, especially since governments require taxes and fees to be paid this way. Moreover, bitcoin’s famous volatility hurts the narrative that bitcoin is like transactional money.
In the long run, bitcoin enthusiasts expect that fiat currencies like the U.S. dollar will continue to act as checking accounts for payments, while bitcoin will act as savings accounts. In other words, government-issued currency will retain its role as a unit of account, while bitcoin will be how wealth is preserved.
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Nobody knows how the big debt cycle will end. And nobody knows if bitcoin’s high volatility will eventually cause supporters to reject its digital gold narrative. If nothing else, the foregoing demonstrates how incredibly complex these issues are. Now you’re ready to click back to the main article that explores the bull and bear cases for bitcoin, Is Bitcoin Immutable and Safe, or Fragile and Risky?
