The Bitcoin protocol resulted after decades of research, experimentation, and failed implementations.¹ The Cypherpunk vision was to create digital money that is free from debasement. The invention of Bitcoin stood to benefit virtually every human being on planet Earth. In essence, Bitcoin represents a social contract that grants the ability for individuals to defer consumption in the present moment with the promise of increased consumption down the road. This social contract has played an integral role in the development of human civilization as we know it. The underlying currency used in human cooperation has shifted gradually through time. Humans throughout history have used many different forms of currency to facilitate the exchange of goods and services. These physical forms of settlement only lasted as long as they were costly to produce in a given society. Some of the earliest forms of money included collectibles crafted from seashells, beads, teeth, and other raw materials.² These ancient forms of money were hijacked throughout history by humans who developed the capability to transport goods from one continent to another. After converging to usage of truly scarce metals like gold or silver as money, humanity was cheated yet again by swaths of greedy individuals. The Cypherpunk movement can be seen as a rational response to centuries of deceit by humanity’s supposed leaders. This chicanery persists today and continues to threaten posterity across the globe.
For thousands of years, humans were able to store their wealth in the safe haven of rare earth metals. The scarcity of these metals is readily verifiable by the reality we live in. Precious metals became widely acceptable because of their inherent scarcity under the Earth’s crust. Problems arose when nations began minting their own coins and stealthily hoarding the scarcest metals for themselves. At the height of the Roman empire, the Roman Denarius consisted of 4.5 grams of silver.³ A mere 200 years later, the Roman government had debased the Denarius down to a consistency of just 5% silver. The remaining 95% was filled with bronze, an alloy that blends common metals like copper and tin. This currency debasement lead to chaos and ultimately the fall of Rome near the end of the fifth century (circa 476 AD).
This scheme of debasing currency to pay for things that are politically difficult to tax evolved into today’s fiat regimes backed by central banks and fractional-reserve-banking.⁵ The details of this scheme are readily available for those who are curious. The takeaway is that national governments have consistently defrauded their constituents to maintain and project power. Nation-states steal their own citizens’ wealth in a manner that is, at first, invisible to the people they are meant to serve. Over the long term, currency debasement leads to price increases in trade and, broadly speaking, ruinous devaluation of the citizenry’s purchasing power.⁶ The decades of invisible theft are finally felt when the citizenry is no longer able to transact in their local currency. What follows is utter destruction of society and inevitably, the State.
We need not belabor the argument that currency debasement is unfavorable for prosperity. There are endless case studies of failed national currencies that survived for only a few decades. The curious reader is encouraged to read texts from scholars like Murray Rothbard, Ludwig Von Mises, Friedrich Hayek, or other scholarship from the school of Austrian economics. The overwhelming volume of historical evidence is sufficient to prove that humanity has been duped over and over again by their nation-state overlords.⁷ With the ever-expanding breath of information at our disposal, we can dispel any notion against this truth. For civilization to progress further, it has become necessary for individuals to take back their economic freedom by restoring private property rights. We cannot deem “capitalism” a failure when the cost of capital has been manipulated by central banks for their own ends. The preservation of wealth eventually leads to robust savings; a vital component which is largely missing from mainstream economists’ equations.⁸ The “economy” fails when the purchasing power of money is coopted by the State.
“I don’t believe we shall ever have a good money again before we take the thing out of the hands of government — that is, we can’t take them violently out of the hands of government, all we can do is by some sly roundabout way introduce something that they can’t stop.”
-Friedrich A. Hayek
As Friedrich Hayek astutely observed, we can’t take the gold and silver back from central banks to restore civilization. What we can do is create an entirely new system to preserve our wealth; a new system which can’t be debased, coerced, or manipulated. This technology can serve as the backbone for society when nation-states fail to provide one for us. Having a sound unit of account is the first step in creating a broadly acceptable medium of exchange. From there, individuals can restore widespread means to interact in commerce without constant state-interference. Individuals can then demand payment in whichever money they see fit to restore the time-value of their labor. This becomes necessary in a world where multinational corporations outlast fiat regimes. Some of these profit-minded machines will remain in place when nation-states go bust. It is up to individuals to level the playing field with sound money and innovation. Preservation of wealth through time leads to prudent planning and a reduction in malinvestment. With the ability to accumulate sound capital through generations, a society can challenge any status quo that is harmful to the collective.
Social Contract in Precious Metals
The usage of precious metals as money represents a widespread social contract between humans. Pure precious metals cannot be counterfeited. A given weight of gold or silver is the basis of value. The historical path of where a particular amount of metal came from is untraceable and irrelevant. Coins can always be melted down to extract their weight and remove any political connotation. The metals are especially dense relative to their value. Storing large amounts of these metals has been problematic but is still feasible. Even the extraction of these precious metals is allowed to anyone who has the means to do so. Gold and silver have maintained their scarcity, fungibility, and salability to this day. Unfortunately, most citizens can no longer afford these metals with the worthless paper notes they’ve been given. The metals still play an important role in storing value for those who are fortunate enough to hold them. Generally speaking, the social contract that bonded humans together when transacting in precious metals can be broken down into several key-components:
- Verifiable scarcity & unforgeable costliness
- Permissionless usage & extraction
- Universal fungibility
If someone handed you a gold nugget in exchange for something, the weight of gold given was all that mattered. Any gold nugget with verified purity could be interchanged with the given nugget in hand. It was understood that gold took time, resources and human labor to extract from the Earth. Everybody could participate in the usage of gold as a medium of exchange. The precious metals remain attractive because they fundamentally still hold these properties; however, precious metals are unlikely to be considered a viable replacement for any scarce currency that is native to the internet. With the advent of Bitcoin and more recent implementations like Decred, humans are on the brink of reviving a similar social contract that is custom-tailored to the digital realm.
The Cypherpunk Social Contract
The social expectations in modern cryptocurrencies bear remarkable similarities to those implicit within the exchange of precious metals. With the advent of these new triple-entry accounting systems, humans are able to verify the authenticity of the digital commodity on their computer or phone screen.⁹ It is cryptographically proven that there are only so many Satoshis (Bitcoin) or Atoms (Decred) in existence. The only way these digital units can be created is through a costly combination of energy, capital, and time. These digital currencies exhibit demonstrable scarcity and costliness. Any amount can be interchanged with like-kind digital units to achieve the same value or function. Humans across the globe are able to extract these digital units for themselves. When these technologies are functioning properly, anonymous users can transact over the internet whenever they need to.
We can compartmentalize the fundamentals of this social contract into three major categories, including Sound Monetary Policy, Permissionless Access and Universal Fungibility. These three categories are hereby classified as the Three Pillars of the Cypherpunk Social Contract. Maintaining and ensuring the strength of each pillar is critical to the survival of these digital specimen. If any pillar is weakened, the entire system and social contract therein can collapse. Only to the extent that cryptocurrencies may be able to defend these three pillars can we later judge their success as sound money.
The Three Pillars Theory
1) Sound Monetary Policy
For the first time in human history, the immaculate conception of Bitcoin allowed for a digital commodity to achieve greater scarcity than any element found in nature. The entire system of participants exists to preserve this fact. The intention behind the code is to create a supply distribution that is immutable. This is an unprecedented feature which understandably has to be seen before there can be widespread belief. The antifragility in Bitcoin has been tightly bound to the promise of a fixed, finite, supply. The market responds to the distribution schedule in Bitcoin after the system follows the code.¹⁰ By this it is meant that the price of a Bitcoin lags behind decreases in the supply curve. This is the natural outcome when distribution is suddenly diminished while demand remains constant. When cryptocurrencies sustain immutability in their hard-coded supply distribution, humans can gradually rely on their use as technology. Figure 3 below shows the monetary policy metrics for both Bitcoin and Decred respectively. While there are thousands of cryptocurrencies in existence, these two projects appear to dominate in terms of overall network security when compared to other implementations. Security should be the number one priority of any cryptocurrency seeking to maintain genuine scarcity through the eons. In this context, security refers to a network’s ability to protect itself from violating monetary policy that is agreed upon by users.
When the trait of scarcity is discussed, it helps to reflect on human behavior during the exchange of precious metals. There is social consensus that these metals come from far beneath the Earth’s surface. The magnitude of human effort put forth to extract these metals contributes to their legitimate scarcity. The cost to produce the metal can be thought of as stored energy in the metal itself. Costliness and scarcity go hand-in-hand. This was also the case when collectibles were used as money. A collectible was only worthy of trade when it was difficult to forge its value.¹² There have been many (many) digital currencies created which cost next to nothing to produce. Those currencies fail to generate genuine scarcity because humans are keenly aware of implied costliness. Detecting unforgeable costliness has become a human instinct for survival and cooperation. Although currencies created out of thin air are profitable for their creators, it is unconscionable to imagine people will be deceived yet again by this scheme which is well-understood and broadly detested by the many.
Sound Monetary Policy is how a currency establishes its purchasing power relative to every other good traded in the open market. This process takes a lot of time, trust, and human effort. These systems are still relatively new and must prove themselves through certain turmoil ahead. Seemingly robust statistical observations of the past will fail to apply to the future should this pillar be weakened or destroyed. Stock-to-flow models and sharpe ratios are certainly useful, but they will only be effective when the anticipated scarcity of a given currency remains static. Should a currency suddenly become cheap to produce or less scarce than humans once thought, the purchasing power of the currency will be diminished proportionately over time. When scarcity is suddenly interrupted in an unpredictable manner, the human experience is akin to direct theft. The rational collective action at that point is to restore order by reestablishing the social contract that was once fruitful for the network. If the arrival of digital currencies makes a clear statement about anything, it is that humans will endure immense sacrifice to reclaim sound money and the cherished contract therein.
Monetary policy is robust to the extent that it can’t be manipulated by a selfish authority. As a consequence of hard-coded supply distributions, cryptocurrencies have overcome the typical stock-to-flow deviations which persist in the physical realm. Humans tend to produce more of a physical good when the good’s price rises in real terms. The ramping up of production often leads to an environment where supply exceeds demand. This, in turn, collapses the good’s price and reduces utility as money. With the advent of hard-coded supply distributions, we now have the capability to circumvent massive fluctuations which bring about unnecessary instability. When money has a predictable supply curve, the result is a stable foundation for economies to build on top of. It is rational for the collective to demand money that is immune to debasement. Beyond providing fairness for economic participants, sound money is perhaps the antidote to needless expansion of government. Sound money, in short, is something worth fighting for.
2) Permissionless Access
The last nail in the coffin for precious metals was arguably the advent of government permission to use them as legal tender.¹³ Today, it’s nearly impossible to purchase these metals without revealing exactly who you are and where your money came from. In the name of combating terrorism, citizens abroad are expected to comply with Know Your Customer (KYC) & Anti-Money Laundering (AML) requirements before purchasing gold, silver, or any other traditional asset. Governments had practically cornered their citizens into using paper notes exclusively; that is, until Satoshi Nakamoto and the Cypherpunks came along with a unique method for global citizens to usurp their economic freedom from the State.
The ability to send and receive scarce digital units without having to trust a third-party is one of the essential pillars in the Cypherpunk social contract. It’s as if we are able to walk up to a complete stranger and physically hand over a piece of gold or silver; except, of course, we can do all of that work from a smartphone or computer within just a few clicks. With sound digital scarcity established, individuals can interact like they used to when exchanging goods and services for precious metals. The fact that the Bitcoin protocol first enabled this interaction is somewhat of a miracle. Without this important property, Bitcoin would likely exist in a vacuum overseen by some central authority. Without the permissionless capacity to send and receive transactions, the promise made explicit by hard code is broken and the social contract can disintegrate.
Another feature of participating in crypto networks is the ability to permissionlessly extract digital scarcity. Similar to the extraction of precious metals, there is a significant barrier to entry to keep in mind; although the capital investment required to begin mining cryptocurrency is arguably more tenable than starting a gold mining operation. With access to a computer and internet connection, individuals can obtain incremental amounts of cryptocurrency. Even though the extraction method doesn’t require authorization, participating in cryptocurrency mining bears similar risks to mining physical ores. We are in the midst of a digital gold rush where there will be winners and losers. Profitability in cryptocurrency mining is tethered to electricity costs and access to capital. This has expectedly produced a hierarchy in mining, but the permissionless nature of this extraction mechanism ensures the possibility of healthy competition. While Bitcoin has relied solely on Proof of Work mining in its distribution, Decred has added additional ways for people to obtain freshly minted currency. When someone is unable to overcome the entry barrier to mining Decred, they might be able to participate in permissionless Proof of Stake to receive newly minted coins. If someone has zero capital to stake or invest in mining hardware, they can still hope to extract Decred through their own labor. With 10% of Decred’s supply distribution placed in a development treasury fund, anybody with an internet connection and a beating heart can participate in its extraction. An integral part of the social contract in cryptocurrency is that anyone can sip from the distribution faucet without permission from authority.
Beyond the capability to transact and extract scarcity anywhere, anytime, digital currencies also empower their holders through confiscation resistance. Upon adequate training, anyone is capable of duping even the most sophisticated burglar. The ability to hide multiple copies off the same wallet ensures that individuals will always have the upper-hand over brute force in the physical realm. Better yet, the most proactive holders can memorize their private keys to hold their wealth inside their own minds. Without the ability to physically locate someone’s property, it becomes impossible to steal away. This simple characteristic empowers humans to stand up for themselves and store the fruits of their labor without needing to trust a bullying bank. On a larger scale, local governments can protect their wealth from invading nations like never seen before. Cryptocurrencies must defend their permissionless nature at all costs. Without doing so, they could share the same fate as those physical currencies which have become relics of antiquity.
3) Universal Fungibility
A scarce money that is fungible retains salability through time. The human desire to price goods in markets is what makes Universal Fungibility an indispensable characteristic of sound money. Modern markets require goods to be priced in currency that is denominated by interchangeable units. This is a fundamental element of pricing goods in the market. When fungibility is absent, a stable pricing mechanism is simply not possible. If collectibles and heirlooms were still the primary currency of human beings, you wouldn’t be able to price anything with complete certainty. Variations in perceived value are prevalent because no two collectibles are equal in physical terms. This risk is likely the reason why humans have not converged to use non-fungible goods as money. Non-fungible goods will assuredly exist as useful stores of value; however, they will inevitably be priced in something that sustains uniformity in value and interchangeability in function.
The closer something resembles a base element in the periodic table, the more fungible it becomes. Pure elements are intrinsically homogeneous, interchangeable and uniform. Any sample of a given element will display properties that are constant. It is this quality where physical goods naturally outshine anything in the digital realm. The interchangeable quality of the elements can be imitated and held as an ideal by digital currencies seeking widespread adoption. An additional characteristic of the elements is that there isn’t a way to discover their precise origination. We know some stars exploded to gift us the various elements around us, but that’s about it. The transfer of physical goods was untraceable until humans began writing things down on ledgers. In the age of digital mass-surveillance, anything that can be chronicled online will likely remain so.¹⁴ The reality of modern KYC/AML requirements is that they increase the potential for malicious actors to attack the fungibility of digital currencies. Given the innate traceability of online activity, preserving fungibility in the digital domain means erasing the history of who has owned a cryptocurrency throughout its lifespan. This is an extremely delicate task because users of digital currencies must still be able to verify scarcity. To sacrifice unmistakable scarcity for fungibility is, to put it bluntly, a fool’s errand. Users must be able to verify monetary policy and retain their individual anonymity. It’s a balancing act.
Thanks to the enhanced dissemination of information, humans have awoken to their shared dark history. With open-source effort and relentless advancement in cryptography, human beings can finally reclaim money that is fungible, scarce, permissionless, and sound. Universal Fungibility might not be essential to stores of value like real estate or art, but it does play a critical role in any currency undertaking the displacement of fiat as the primary method to price goods in the open market. If two currencies are considered equal in terms of Sound Monetary Policy and Permissionless Access, the currency that is more fungible will display superior resilience as sound money.
Conclusion
The era of paper money has run its course and humans must now ask themselves if the benefits outweigh the costs. Should we ever adopt a currency that isn’t costly to produce? Are we okay with the stealth tax of inflation and the slow march of paper moneys toward their inevitable demise? Can we build a society that is free from central banks and all problems they seem to create? Is it acceptable to have every single transaction scrutinized by some central authority? These are questions we must grapple with as we evolve into a more civilized society. Money is at the heart of all these issues and it is up to us to demand money that is fair.
The social contract known as money is derived from our lack of coincidence of wants. Sound money is a necessary feature to bridge this natural phenomenon in a capitalist society. Humans have historically relied on their governments to protect their property through the rule of law. What has become abundantly clear is that these governments are no longer ruled by the people or their own laws; but rather, they have been captured to rule in favor of a select minority. Our national governments have proven corruptible in every single instance. State-control over money has been a complete and utter failure. When the hoards of paper currencies reach their inexorable destruction, modern cryptocurrencies will be there to reinstate power back to the people.
“Capitalism is the fullest expression of anarchism, and anarchism is the fullest expression of capitalism. Not only are they compatible, but you can’t really have one without the other. True anarchism will be capitalism, and true capitalism will be anarchism”
-Murray N. Rothbard
Capitalism and statism have indeed proven themselves incompatible. Capitalist ideals of private property, capital accumulation, wage labor, and competitive markets can emerge without state-control over money. This was the case during the 19th century when most countries were on the gold standard.¹⁵ Anarchy is derived from the Greek word, anarkhia, meaning “without a ruler.” Decentralized cryptocurrencies are anarchy in its purest form. Voluntary cooperation between human beings has emerged to reject an unjust system which has been catastrophic for society.
The Theory of Three Pillars in the Cypherpunk Social Contract serves as a mental model for the intrinsic properties of sound money. This theory posits that whichever currency adequately defends The Three Pillars will withstand the test of time, but it is ultimately up to the market to decide which currencies to adopt. Sound money must be chosen by the collective. Many cryptocurrencies are competing to safeguard the contract of sound money by using considerably distinct methods. This theoretical framework will serve as a foundation to compare these digital currencies and later assess trade-offs in risk.
-Cato
References
[1] Satoshi Nakamoto (October 31, 2008) Bitcoin: A Peer-to-Peer Electronic Cash System https://bitcoin.org/en/bitcoin-paper
[2] Nick Szabo (2002) Shelling Out: The Origins of Money https://nakamotoinstitute.org/shelling-out/
[3] Jeff Desjardins (February 18, 2016) Currency and the Collapse of the Roman Empire https://money.visualcapitalist.com/currency-and-the-collapse-of-the-roman-empire/
[4] Jeff Desjardins (February 18, 2016) Currency and the Collapse of the Roman Empire https://money.visualcapitalist.com/currency-and-the-collapse-of-the-roman-empire/
[5] Llewellyn H. Rockwell Jr. (October 31, 2019) How Central Banks Fund Our Age of Endless War https://mises.org/library/how-central-banks-fund-our-age-endless-war
[6] Frank Shostak (December 21, 2016) Why Are Dollar Bills Worth Anything? https://mises.org/wire/why-are-dollar-bills-worth-anything
[7] Saifedean Ammous (April 24, 2018) The Bitcoin Standard: The Decentralized Alternative to Central Banking. Wiley.
[8] Roger W. Garrison (June 6, 2018) The Absurdity of Keynesian Economics https://mises.org/wire/absurdity-keynesian-economics
[9] Permabull Nino (May 21, 2019) Bitcoin: An Accounting Revolution https://medium.com/@permabullnino/bitcoin-an-accounting-revolution-40efcb903d7b
[10] PlanB (March 22, 2019) Modeling Bitcoin’s Value with Scarcity https://medium.com/@100trillionUSD/modeling-bitcoins-value-with-scarcity-91fa0fc03e25
[11] Checkmate (October 14, 2019) Decred, Following in Bitcoin’s Footsteps https://medium.com/@_Checkmatey_/decred-following-in-bitcoins-footsteps-f8d0e0bbaff5
[12] Nick Szabo (2002) Shelling Out: The Origins of Money https://nakamotoinstitute.org/shelling-out/
[13] Thomas E. Woods Jr. (August 13, 2008) The Great Gold Robbery of 1933 https://mises.org/library/great-gold-robbery-1933
[14] Edward Snowden (September 17, 2019) Permanent Record. Metropolitan Books.
[15] Saifedean Ammous (April 24, 2018) The Bitcoin Standard: The Decentralized Alternative to Central Banking. Wiley.
