Bitcoin is booming. No one can deny that. The mainstream attention it receives is huge and growing every day. After years of getting suspicious looks whenever I talked about Bitcoin, I’m now constantly and repeatedly approached by people hungry for information.
Nevertheless, from all around — including from some veterans of the bitcoin space — I still hear a lot of talk about how Bitcoin can only be used as a store of value, or only as a speculative asset. This post is stating what I think is the obvious: Bitcoin is here to stay, and fiat is dead.
The evolution of money
Barter
Before money there was barter. There is a saying that barter is no good since it can take a while before a barefoot baker finds a hungry shoemaker. This saying is amusing, but it points to something quite astute about a key metric of effective money: enabling as many voluntary transactions as possible.
Commodity money and cash
Barter was replaced by a generally accepted means to transfer and store value (or “money”) around 9000 BCE. Different objects were used for this purpose in different places and by different cultures, from barley in the near east and mesopotamia to seashells and beads in the Americas. Eventually, precious metals assumed this function almost everywhere. All of these forms of money already supplied the three basic functionalities of money:
- Medium of exchange — When I sell goods or services, I don’t need to find someone that has a specific good that I want. If I live in a society where seashells are money, I can sell my wares to anyone in exchange for seashells.
- Store of value — The reason I’m willing to accept seashells in exchange for my goods is not because I need seashells, but because I know that I’ll be able to buy bananas with them tomorrow — or next week, or next year. I can build wealth (and all it implies — security, freedom, etc) by amassing a stash of seashells.
- Unit of account — Very soon everything is measured is seashells, which enables the pricing system — one of the most important concepts in economics.
Different materials are variably suited to being effective forms of money, according to properties like:
- Scarcity — sand is not a good money. :)
- Durability — maintaining its form over time. Bananas are not good money since they rot.
- Fungibility — every two units of money should be interchangeable.
- Unforgeability — impossible to fake.
- Recognizability — easy to recognize when legitimate.
- Transferability — easy to move from person to person and place to place.
- Divisibility — easy to divide, to buy small things, and to still use if the value is rising.
- Privacy — no one should be able to know who you are when you are transacting.
- Uncensorable — the owner of the money is in complete control over it.
- Acceptance — the most important property: the amount of trust the public has for this form of money.
One can of course think of different categories, and the ones suggested here are not really independent. In addition, the suitability of a given currency is subject to change over time, as environmental factors shift. For example, paper notes scored high on transferability in the pre-electronic world, but in a digital and globalized world they score very low on these metrics.
Over time, money evolved to have better properties. For example, coins were minted to produce money that was more fungible and more recognizable. Later, paper money came along — initially as a way of tracking debt for commodities — featuring greater transferability than coins.
Fiat and electronic fiat
Fiat is a weird notion of money. The value of it does not emerge naturally due to its good properties, rather, the value is assigned and enforced by some authority.
Fiat was invented quite early (around the 11th century), but only became widely used in the 1970s when President Nixon eliminated the gold backing of the dollar. There are several problems with fiat as a form of money. A major one is that it scores low on scarcity, since the issuing authority can print as much as they like, resulting in inflation, as was brilliantly mocked by Dr. Evil.
Then came a move from physical fiat to electronic fiat — a shift almost as radical as turning to fiat in the first place. It is estimated that less than 10% of all money supply is in the form of cash fiat. Electronic fiat gives even more control to the authority over the money supply. The main difference is that a classical cash transaction has only two participants, whereas in an electronic fiat transaction there always is a middleman. Due to the middleman, electronic fiat scores very low on privacy, and carries greater possibility of censorship, as the mediator has the ability to prohibit transactions. The ability to stop transactions, hold funds locked, and even confiscate funds can be used to demand detailed reports about every transaction.
An individual may earn fiat money by work or investment, and an authority, directly or in the form of a financial custodian, may part the individual from his private ownership of those monies. Fiat becomes thus a conditional private property, and the monetary custodian is effectively turned into a law enforcement agency. In this agency, one is often treated as guilty until proven otherwise.
Bitcoin
We are fortunate to be witnessing one of the greatest evolutions of money. Bitcoin (I use Bitcoin as a representative for cryptocurrencies in general) is the most advanced and effective form of money we ever had. The main reason is: it was carefully designed to be just that.
If we measure it according to the properties we have listed before, Bitcoin’s score is off the chart. Scarcity-wise it is perfect, as there will never be more than 21 million Bitcoins, and the inflation rate is known to everyone in advance. Bitcoin is not held in any specific location; it is a decentralized network, which makes it almost indestructible, so durability-wise it is very good. Since Bitcoin is based on solid math and cryptography, no one can produce a counterfeit — it’s unforgeable. The decentralized structure allows anyone to verify all transactions all the way back to the genesis block, so anyone can recognize it without needing to trust anyone else. Divisibility is very easy with digital money — Bitcoin currently has eight decimals, and that can be increased in the future. Bitcoin is also uncensorable, as there is no central authority that can prohibit transactions.
There are two properties on which Bitcoin does not score very high (although still higher than Fiat): fungibility and privacy. This is because the blockchain is a public ledger, open to everyone. It is what we call pseudo-anonymous, namely you can know only the addresses — not the owners, but this is often enough data to analyze in order to later trace people on gateways. Because the history of transaction is known to everyone, protocol wise Bitcoin protocol is not fungible. Fungibility is enforced in Bitcoin only as a social rule. Nevertheless we see intense work on these issues within the crypto community. One solution worth mentioning is zero-knowledge proofs, as implemented in ZCASH.
One interesting property is transferability. On the one hand Bitcoin is the money of the internet, and you can send it to anyone just like you send an email, so it is very transferable. On the other hand, there is the issue of scalability — namely the limit on how many transactions the network can process per second. However, thanks to the great minds working on blockchain we see rapid progress on this front, either in base protocols improvements such as Spectre, or in second layer protocols like lightning networks.
Adding to all of the above the growing acceptance of bitcoin — with millions of new users every month and people selling cars and houses for Bitcoin. The conclusion is unavoidable: cryptocurrencies are here to stay. They are fiat’s slayer.
Dead or alive?
Some will say fiat is not dead yet, and that the fight is undecided. Fiat is widely used everywhere, and by every economic measure it is orders of magnitude bigger than Bitcoin. I believe fiat is like a star, many light years away, that is already long gone. The fact we see the light is merely due to the distance, however it’s nothing more than an optical illusion. Looking at Bitcoin is like looking on Karl Benz’s motorwagen: carriages are still everywhere, but they are dead as a doornail.