Monetary Energy, Money & Bitcoin

TLDR: Flow of monetary energy into a monetary asset determines its collective value. Traditional money is not a reliable way to store and transfer monetary energy as it fails to meet the basic principles required to be sound money. Bitcoin fixes these problems, which makes it good at storing and transferring monetary energy. This is why monetary energy will continue to flow into the fixed number of Bitcoin in the Bitcoin network, increasing the value of each Bitcoin.

Disclaimer: Nothing in this article constitutes professional / financial advice. It is my personal opinion and should be treated as such. Please do your own due diligence and research.

I watched a video where Michael Saylor, CEO of MicroStrategy was being interviewed by Keith Mccullough on the long-term case for Bitcoin. He said, “Bitcoin is the first software network in the history of the world that can pull monetary energy… [monetary energy] can sit there like in a battery and not bleed out like 2–4% a year, and I can put in the palm of my hand and move it around the world for a few dollars in a few minutes.”

This got me thinking a lot about the concept of monetary energy, and viewing money as a conduit of transferring this energy. By thinking about it, I realised that if we viewed money in terms of energy, it would be a lot easier to understand money, Bitcoin’s value, and by extension, its place in our monetary system moving forward.

Monetary energy

When we produce a good or service, we’re creating value if there’s another party that derives value from what has been created. This value that is created has very similar properties to energy, so we’ll call it monetary energy.

Before money was invented, one had to consume their monetary energy immediately after creating it. For example, if one were to sell a goat, he would have to exchange that for something of equivalent value, that probably could not be stored long term and had to be consumed practically right away. He wouldn’t have been able to store this energy created.

Therefore, humans created a battery to store this monetary energy, and we called it money. This money then became not only a store of value, but a medium of exchange.

History of Money

The first iterations of money were pretty basic and intuitive. First of all, it had to be something that was difficult to create. If it was easy to create, the flow (remember the term flow, this will be important later) of new money into the system would be far greater than the new monetary energy created.

In energy terms, imagine if you have a solar farm with a fixed number of panels (energy is being created at a constant pace), but you keep adding more batteries into the system to collect this energy. The average amount of energy in each battery diminishes over time. Therefore, the value in energy terms per battery, decreases. If you increase the number of batteries too fast, soon all of your batteries will have miniscule amounts of energy, and would be practically worthless.

There were many early forms of money, such as seashells, glass beads, and rai stones. Rai stones are most similar to Bitcoin, but that’s another topic in itself. You may read more about it here.

All the early forms of money had something in common. They were difficult to create initially, but became easy to create as technology advanced, which made these forms of money become worthless overtime as a store of monetary energy or medium of exchange.

With the early failures of money, humans stumbled upon precious metals. These were extremely rare and difficult to mine, and even with improvements in technology over centuries, it was still not easy to create due to its scarcity. Finally, we created the first basis for sound money.

Properties of sound money

1. Scarce

2. Difficult to create / forge

3. Easy to transfer from one person to another

4. Durable (does not lose value over time)

5. Fungible (mutually interchangeable. I.e. 1g of gold from person A is the same as 1g of gold from person b, unlike beads where its beauty and value are subjective.)

6. Divisible

Precious metals have most of these properties, but to varying degrees. For instance, it is scarce and finite on earth, and requires a lot of work to create more of. However, it may not be totally scarce forever, as humans may eventually be able to mine gold from asteroids in space.

It’s also not that easy to transfer from one person to another. It’s heavy and impractical to pay for something like your house in gold.

Although it’s technically divisible to any fraction imaginable, it’s not easy to do so. For example, if one wanted to buy a paper clip, he’d need to melt his gold bar down and create a speck of gold to pay the seller.

Humans then had the brilliant idea to use paper backed by gold, which were essentially IOU notes for that underlying gold. This made it easy to transfer, and easily divisible into standard units of measurement.

However as monetary systems are centrally controlled, money would usually be debased in some way, for political reasons / human greed.

Example 1: Rome

In Rome, every legal tender coin had a percentage of precious metal in the coin. The Aureus was the gold coin, denarii the silver coin, and sestertius the bronze coin.

As the roman empire expanded, they needed more money to pay the soldiers, farmers and other workers. They realised that the solution was rather simple. Just collect all the existing coin, melt it down, and issue new coins with less gold content. If they reduced the amount of gold in a coin from 100% to 90%, they suddenly increased their coffers by 10% overnight without having to produce anything. This was one of the first instances of currency debasement. They kept doing this repeatedly over the years, until the gold content in every coin was less than 10%.

In monetary energy terms, each coin had technically lost 90% of the monetary energy that it stored. That was like a solar farm increasing the number of batteries by ten times, but producing the same amount of energy. Each battery had way less energy and was less valuable.

Some historians mark this as one of the key reasons for the fall of the Roman Empire.

Example 2: US and the move away from the Gold Standard to Fiat currency

“We have gold because we cannot trust governments”

— President Herbert Hoover to Franklin D. Roosevelt.

Prior to 1973, the US dollar was on the gold standard. That is, every dollar was backed by the equivalent value of gold.

After WWII, they convinced all of their allies to send them their gold reserves in exchange for US currency which they could use as their reserves instead. As every US dollar was redeemable for gold, the other nations didn’t think anything of it.

However, in 1973, the US went off the gold standard, which essentially meant that the US dollar was no longer redeemable for gold. That is how the US became the largest holder of gold in the world and how money became unsound, losing most of the properties discussed above. Governments could now print more money without requiring it to be backed by any gold or precious metals.

More than 61% of all foreign bank reserves are denominated in US dollars, and if the US dollar is unsound, what does that make all other currencies that are backed by it?

Money is no longer scarce, durable or difficult to create.

Bitcoin

Bitcoin was created to replace our current monetary system by fulfilling the principles of sound money. By being the best form of money, monetary energy would be pulled into the network as people begin to realise that it is the best place to store one’s monetary energy.

1. Scarce — Bitcoin has programmable scarcity, where only 21 million coins would ever be created. It is literally impossible to change the hard cap on Bitcoin, or discover more bitcoin somewhere else in the universe.

2. Difficult to create / forge — Programmed into the code is a model called Proof of Work. Computers need to solve an extremely complex mathematical puzzle in order to mine a Bitcoin, and there’s a cap to how many Bitcoin can be mined — about 900 Bitcoin per day as of Oct 2020. If more people try to mine it, the puzzle becomes even more difficult to solve, increasing the amount of computing power and electricity (physical energy) needed to solve it. Logically, the price to mine one bitcoin is highly correlated to the price of Bitcoin itself, and can be used to spot market bottoms. That is, if the cost to mine a Bitcoin is higher than the price to buy it, miners would just buy it rather than mine it, which would increase the buying pressure.

3. Easy to transfer from one person to another — Bitcoin can be transferred from anyone to anyone else around the world extremely easily, with no exchange rate and no middleman required. Anyone can create a Bitcoin wallet, and all you need is to buy some Bitcoin on an exchange, send it to your wallet, and you can then send your bitcoin to any wallet address. There are no exchange fees and no middleman. The largest transaction recorded was $1.15B moved, and the network fee for the transaction was only $3.58. With layer 2 solutions like lightning network being built for Bitcoin, transaction speeds will only increase, and network fees will decrease over time.

4. Durable (does not lose value over time) — As a new asset class, Bitcoin is extremely volatile and will see huge upswings and downswings, but if you zoom out and look at the long-term trend, the volatility has been decreasing. Eventually, Bitcoin will stabilise at a particular value with small price fluctuations, after most of the world’s monetary energy is stored on Bitcoin’s network.

5. Fungible (mutually interchangeable) — Some may argue that Bitcoin is not entirely fungible, as a Bitcoin used for money laundering and illegal activities may be “tainted”, and worth less than the value of another Bitcoin. However, there are two arguments against this. One is that it’s not that important in this case, as only a small fraction of Bitcoin is tainted, and if no one wants to buy the tainted bitcoin, it will reduce the supply of circulating Bitcoin, which will increase the value of all other Bitcoin (or monetary energy stored on all other Bitcoin). Secondly, an opensource community of developers are constantly improving Bitcoin, and one day they may solve the fungibility problem.

6. Divisible — Bitcoin can be divided into 8 decimals (called 1 satoshi). I.e. 1 Bitcoin = 100 million Satoshis. So, if 1 Bitcoin becomes worth $1 million, a Satoshi would be worth 1 cent.

There are many other features that make bitcoin great that I haven’t covered, but maybe I’ll do so in another article.

Never in history has humanity created a form of money that is able to store and transfer monetary energy anywhere around the world practically instantly, without any middleman or central authority controlling its supply, creation and distribution.

Stock-to-flow ratio

Earlier, I mentioned how the “flow” of new money into the system affects the amount of monetary energy stored on each unit of money. If the flow of new money created is higher than the amount of net monetary energy flowing into the system, the value per monetary unit decreases. If the flow of new money created is lower than the amount of net monetary energy flowing into the system, the value per monetary unit increases.

Like in my battery example, imagine we add more solar panels to our solar farm and we add more batteries at a slower rate than we add solar panels. Overtime, the amount of energy stored in the batteries will increase.

Stock-to-flow is one of the ways to determine the speed of new flow of money into a system, and is important in determining the value of scarce assets. Essentially, it’s the length of time it takes to double the amount of existing stock. Gold’s stock to flow ratio is about 66, meaning it takes 66 years to double the amount of Gold already mined in the world. Silver’s is 22, which is one of the reasons why Silver is much less valuable than Gold.

Bitcoin’s stock-to-flow ratio is currently 25, but it is also unique, in that the flow of new bitcoin is automatically halved every 4 years, commonly known as The Halving. That means overnight on the date of the halving, it becomes twice as hard to mine one bitcoin as it did the day before, and the stock to flow ratio increases. Eventually, bitcoin will reach a point where there will be no more flow at all, once the total number of Bitcoin mined hits 21 million coins.

Imagine the flow or new supply shrinking over time, but the transfer of monetary energy into the bitcoin network increasing over time as the rate of adoption increases.

Bitcoin’s value and price swings can be largely modelled closely to its stock-to-flow ratio. An analyst and investor called Plan B came up with the stock-to-flow model for Bitcoin, and you can see that it is largely correlated as expected.

Plan B’s Stock-to-flow model charted against Bitcoin’s price

The stock-to-flow model acts as a magnet for Bitcoin’s price whether up or down and serves as an indication for the intrinsic value of Bitcoin at any point of time. In bubbles you can see that it overshoots the intrinsic value and gets pulled down in a correction or “crash”. Based on this model, the intrinsic value as of the last halving per Bitcoin is modelled to be $100,000. We’re currently being pulled up by this magnet, and we’ll most likely overshoot the $100,000 valuation in the next bubble as humans usually do due to human psychological factors, such as the fear of missing out when the price starts to spike. We’ll then likely see another crash as early investors move the additional monetary energy that they’ve gained into other assets like property, stocks and other investments. These market cycles are just a part of Bitcoin’s early adoption years, and over time we will likely see more price stability.

Mass adoption

More people are starting to understand bitcoin, including average folk, millionaires, billionaires, small companies and listed companies. In the last couple of months, we’ve seen a number of large cap companies like MicroStrategy, Square, Mode, and billionaires like Paul Tudor Jones start transferring a portion of their reserves (their stored monetary energy) into Bitcoin.

As currency printing continues in the US and around the world, it wouldn’t be farfetched to predict that hundreds, if not thousands of companies will start doing the same.

PayPal has also announced that they will allow customers to purchase Bitcoin through PayPal, and merchants to accept Bitcoin payments. DBS Bank has also recently announced its digital assets exchange (pending regulatory approval), that allows institutional investors to buy and store Bitcoin and other cryptocurrencies through the bank.

All of this will further increase the monetary energy flowing into this limited number of monetary units that can never be artificially expanded.

Bitcoin is on a rocket ship not just to the moon, but to another galaxy, and monetary energy is the fuel.

Credit to The Bitcoin Standard, by economist Saifedean Ammous where many of the ideas shared were originally from. I merely added an additional analogy of monetary energy and applied it to many of his examples. Do get his book if you’re interested in diving deeper into Bitcoin.

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