Bitcoin as an Instrument for Uncertainty Reduction — A Sociological Perspective on Money
Written by Paolo Di Stefano — August 9th 2022
Bitcoin’s tremendous growth in popularity across the globe sparked a lively debate on what money fundamentally is and what purpose it should serve. Meanwhile, in the framework of the course “Uncertainty and Uncertainty Reduction” taught at the University of St.Gallen, sociologist Prof. Ph.D. Patrik Aspers introduced the class to a refreshing new perspective on the world as we perceive it:
According to the early 20th-century economist Frank H. Knight “Life is made up of uncertainties”, and since this is an elemental issue that constantly plagues us, almost all our actions are ultimately targeted at reducing these uncertainties (Knight 1921).
Through this refreshing frame of mind, this article explains the term uncertainty in more detail, then connects the main evolutionary steps in the history of money with the concepts introduced in sociologist Prof. PhD. Patrik Aspers’ book Uncertainty Reduction: Coping with a Complex World (expected in 2022), and ultimately evaluates whether Bitcoin is a viable instrument for uncertainty reduction in comparison to the FIAT money we currently use.
1. What is Uncertainty?
Finance students (like myself) frequently confuse uncertainty with risk: while risk requires us to be able to identify a set of possible outcomes and assign objective probabilities to each of them, uncertainty also prevails “when it is neither relevant nor possible to put numbers on many alternatives” (Aspers 2022). Therefore, uncertainty is a more profound phenomenon that is discussed in disciplines such as economics, management, anthropology, and sociology alike (Aspers 2022).
In Arrow’s (1974) words, uncertainty arises whenever we lack “a complete description of the world which we fully believe to be true”. And although a world of complete certainty is a utopian state (Aspers 2022), we have developed various kinds of strategies that help us to reduce at least some of the uncertainties.
2. The Evolution of Money
Before we can evaluate which type of money serves the purpose of uncertainty reduction best, we first need to understand what money is and how it came to be. For this reason, I would like to give a summary of Saifedean Ammous’ version of the history of money in his recently released interview with Lex Fridman (2022). Ammous is an Austrian-school economist who published best-selling books on both the FIAT standard as well as on Bitcoin and counts as one of the harshest critics of current monetary politics.
2.1 A Medium of Exchange
Ammous defines money as a good that we do not acquire for its own sake, but because we plan to exchange it for something else at a later point in time — It serves as a medium of exchange.
The need for a medium of exchange arises from the issue of the coincidence of wants. This is best explained by an example: Alice has ten apples and wants ten bananas. Bob wants Alice’s ten apples but has ten oranges. To solve the issue of coincidence of wants, Bob needs to find someone who wants his ten oranges and offers him ten bananas. If Bob succeeds, then he can use the bananas as a medium of exchange to acquire Alice’s apples.
The central point is that he would not acquire the bananas for their own sake, but only because he plans to exchange them for the apples. Ammous (2022) then argues that humanity has seen a wide range of goods that have served as media of exchange over time, and it is natural for them to evolve and emerge as an economy becomes more sophisticated.
2.2 From Bananas to Gold
The second purpose of money is to serve as a store of value. As humans became more future-oriented, they started trading what they had in excess for a medium of exchange before they knew what exactly they would want to exchange it for later. Now two main properties start to matter: the chosen good needs to be both durable and scarce, to make sure it best preserves its value over time.
Naturally, gold has proven to best fulfill these properties, for which the reason lies in chemistry. Gold is indestructible (durability) and can not be created or cultivated, but only strenuously gained from mining (scarcity). For this reason, the people of many societies throughout history have mutually adjusted to using gold as money (Ammous 2022).
This is an excellent example of what Aspers (2022) defines as a grown institution, which is a (public) way of reducing uncertainty. Grown institutions are the result of actors mutually adjusting to one another to facilitate both interaction and coordination amongst them. Grown institutions are internalized by people (Aspers 2022), in this case meaning that people had started taking for granted that the gold they possessed would be considered valuable by others also in the future. Hence, gold gave them the ability to exchange what they had in excess in the present for whatever good they would come to need later in their lives, thereby reducing their uncertainty about the future.
2.3 Paper Certificates
The next step in the evolution of money was the answer to two limitations gold has: It can not easily be divided into smaller pieces, and it is not practical to be carried around. The introduction of national currencies solved this issue. Governments started storing gold on behalf of their citizens and issued paper certificates (“receipts”) for the gold that was deposited with them.
Governments decided on specific units of gold the introduced certificates represented, and initially, each certificate allowed the owner to redeem it for the corresponding amount of gold if so desired. Now, people could simply pass these paper certificates to one another when trading goods, instead of the gold itself. Therewith, paper money was born (Ammous 2022).
To make the connection back to Aspers (2022), this is a great display of how a grown institution is turned into a decided rule, which is another (public) way to reduce uncertainty. Contrary to grown institutions, decided rules are more formal and are “backed by an organization that has the power to implement sanctions” (Aspers 2022). This is the case for national currencies, as the government will impose sanctions on citizens that do not adhere to the outlined rules, for example by trying to fake the certificates.
2.4 It Shall Be Money
Governments later realized that, if not everybody would redeem their gold at the same time, they could issue more “receipts” than they had gold. This concept is today referred to as money creation in economics, which according to Ammous (2022) started as a “fraud”. But it got even worse when governments realized they still did not have enough money to come up for all their expenses, and finally decided to simply force people to accept and use the money they issued, even if it did not correspond to any amount of gold they had in storage.
This detachment of the national currencies from physical gold about 50 years ago was the death of the monetary Gold Standard, and the birth of FIAT money (Ammous 2022). The term fiat is Latin and can be translated to “it shall be” or “let it be done”. Hence, FIAT currencies only have value because the government stipulates so, but not because there is any real underlying value to them (Chen 2022).
From Aspers’ perspective, Ammous tells us that governments altered the rules of how money works in their favor and to the expense of the citizens. Governments can now simply create new money when necessary, but citizens can not rely on the natural scarcity of gold anymore to transfer their purchasing power into the future. This translates into less uncertainty for governments, and into more uncertainty for their citizens.
However, one could also argue that governments would now be able to reduce uncertainties for their citizens in other aspects. As an example, it expectedly would not have been as easy for governments to financially support businesses and citizens that suffered from the Covid crisis under the Gold Standard. In a more abstract sense, the governments’ new ability to create money at the press of a button could be viewed as country-wide insurance against macroeconomic shocks, with insurance being another tool for uncertainty reduction (Aspers 2022).
2.5 Electronic Payment Networks
In the last evolutionary step, (FIAT) money additionally became mostly electronic (only 10% of US dollars exist as cash). This greatly increased its transactional efficiency compared to paper money for obvious reasons. However, it also led to a loss of sovereignty for citizens and a gain in power for governments; wire transfers are not anonymous such as cash transactions, and the government can freeze bank accounts at any time, therewith denying citizens the ability to access their wealth and to transact with others (Ammous 2022).
On the one hand, this power gain expectedly results in more security (less uncertainty) for law-abiding citizens as criminals can be identified and sanctioned more easily. On the other hand, this also represents a new tool for the government to monitor its citizens and oppress political opponents. Whether this development is perceived as positive or negative in terms of uncertainty reduction ultimately depends on both the benevolence of the government towards its citizens as well as on one’s ideological attitude towards making the government more powerful.
3. Is Bitcoin Better Money?
Bitcoin claims to be the first version of electronic money that solves the double-spending problem using a peer-to-peer network; previous versions of electronic money relied on a central authority that made sure users could not trick others and spend more money than they had. With the innovative approach Bitcoin’s anonymous creator took, this can now also be prevented in a completely decentralized manner (Nakamoto 2008).
3.1 Durability and Scarcity
To recall, in many societies people had mutually adjusted to using gold as their preferred medium of exchange as, being the most durable and scarcest good available, it would best preserve its value over time.
While gold is as durable as it gets because of its chemical properties, Bitcoin could theoretically only cease to exist if there are no more computers left that keep an honest record of all the users’ account balances and transaction logs (the blockchain). However, Bitcoin’s utility would significantly start to suffer already before that as with a too-small number of computers in the network, the blockchain loses its immutable and censorship-resistant properties.
Considering there are currently so many computers in the network that they consume about 0.55% of the global electricity production (Carter 2021) as well as the fact that the protocol is designed to financially incentivize new computers to partake when others leave (Nakamoto 2008), such an event is however extremely unlikely. Therefore, Bitcoin scores only slightly lower than gold in terms of durability at its current network size.
A good’s scarcity on the other hand can be quantified by looking at its inflation rate. Estimates suggest that gold supply currently grows at approximately 1.5–2% per year due to mining activity (Ammous 2022).
In the case of Bitcoin, inflation is precisely programmed. Bitcoin supply currently expands at around 1.8% a year. This number is halved approximately every 4 years, and the total supply of 21 million Bitcoins will expectedly be in circulation by the year 2140, meaning that the inflation rate would decrease to 0% until then (Ammous 2018). Bitcoin’s scarcity is therefore currently comparable to gold’s but should soon become supreme. It is therefore no wonder that Bitcoin is often referred to as Digital Gold or Gold 2.0.
3.2 Divisibility and Transferability
The money we currently use is however not gold, but (electronic) FIAT money. Hence, Bitcoin also needs to be analyzed in terms of the improved divisibility and transferability that the introduction of national currencies brought. Divisibility-wise, none of the two has an advantage as both can be divided into sufficiently small denominations.
In terms of transferability, there are two main differences. While for Bitcoin transactions national borders do not matter at all, FIAT money usually needs to cross multiple payment networks before reaching recipients in other countries — which can take multiple days and might entail high fees (World Bank 2021).
Furthermore, wire transfers can be monitored and interrupted by national governments (as outlined in section 2.5). Bitcoin transfers on the contrary are pseudonymous, censorship-resistant, and completely final (meaning they can not be reversed). This reduces the uncertainty of both the senders and the recipients of the funds as nobody can interfere with a transaction. The finality of the transfers however comes with the catch that the funds can not be reclaimed when sent to the wrong address, counter-balancing the suggested uncertainty reduction for senders.
3.3 Price Volatility
Even though Bitcoin might seem like the most advanced type of money we have “on paper” (Ammous 2022), its main drawback certainly lies in its high price volatility compared to Gold and national currencies. Throughout thousands of years, people mutually adjusted to gold’s status as a valuable precious metal — making it a deeply internalized grown institution. National currencies on the contrary are decided rules, meaning that they are backed by powerful central authorities.
Bitcoin is so far neither of that; The number of people that regard Bitcoin to be valuable is growing but fluctuates daily, and there are so far only a handful of governments that actively declared it to be a legal tender in their countries (giving it legitimate monetary status).
In consequence, people can not just rely on Bitcoin to preserve its value over time but need to speculate that a growing number of people will mutually adjust to deeming it valuable. This ultimately creates a situation analogous to the beauty contest first presented by Keynes (1973): the decision on which type of money people choose to use as a store of a value over time needs to be based on their anticipations of which they expect others to choose.
4. Conclusion
Before national currencies were introduced, people had mutually adjusted to using gold as money because of its durable and scarce nature. Since grown institutions usually take very long to become established, the test of time will have to show to what extent Bitcoin can become a grown institution for value preservation as well.
To become a decided rule, on the contrary, governments across the globe would need to give Bitcoin clearer legal status. Cryptocurrency regulation is still being developed in many countries and making Bitcoin the primary medium of exchange would result in a loss of power for governments as well as for central banks, which could not implement monetary policy measures anymore.
Due to its two most important properties (scarcity and censorship-resistance), Bitcoin becomes an attractive instrument for uncertainty reduction mainly in two scenarios:
When national currencies get out of control and citizens realize that, as time passes, they can afford less and less with the money they saved up, the demand for an alternative store of value rises. It is therefore not surprising that Bitcoin adoption has recently bloomed in Turkey where inflation is at an all-time high (Pitel 2022).
Besides that, the demand for a censorship-resistant and pseudonymous type of money increases when governments become extraordinarily powerful. It is therefore also no wonder that in China (a totalitarian state according to Babones (2021)), the government deemed it necessary to impose bans on various cryptocurrency-related activities (McGregor 2022).
References
Ammous, Saifedean (2018). Can cryptocurrencies fulfill the functions of money? The Quarterly Review of Economics and Finance: Journal of the Midwest Economics Association, 70, 38–51.
Arrow, Kenneth. 1974. The Limits of Organization. New York: W.W. Norton &Company.
Aspers, Patrik. 2022. Uncertainty Reduction: Coping with a Complex World. University of St.Gallen: not yet published.
Babones, Salvatore. (2021, April 10). Yes, you can use the T-word to describe China. Foreign Policy.
Carter, Nic. (2021, May 5). How much energy does Bitcoin actually consume? Harvard Business Review.
Chen, James. (2022, April 20). What is Fiat Money? Investopedia.
Dodd, Nigel. 2005. “Reinventing Monies in Europe.” Economy and Society 34(4):558–83.
Keynes, John Maynard. 1973. The General Theory of Employment, Interest and Money. London: Macmillan.
Knight, Frank. 1921. Risk, Uncertainty and Profit. Boston: Houghton Mifflin Company.
Nakamoto, Satoshi. (2008) Bitcoin: A Peer-to-Peer Electronic Cash System.
Pitel, Laura. (2022, June 3). Turkish inflation hits 23-year high of 73.5%. Financial Times.
