Here's Why We Need Bitcoin [Part I]

The objective of this series of posts is to show why Bitcoin is a better form of money than the ones we currently use. For that, however, we first need to think about some fundamental concepts without which considering Bitcoin in a serious way is impossible.

In this sense, this first post will explore those concepts. With this base, in subsequent posts, I will examine Bitcoin more thoroughly and demonstrate why it’s better.

Money is Not Natural

I think understanding Bitcoin is hard because, in addition to its technical aspects, which are a world by themselves, it requires understanding what money is.

And money is something so known and common that it’s hard to be open to the possibility that we don’t really know what it is. Because of its ordinariness, we understand money almost as a natural phenomenon when, in fact, it’s far from being one.

Money, to use Yuval Noah Harari’s framework, is a myth we created, and in which we decide to believe in because it makes life easier. In other words, money is a social construct; it’s a human invention.

Proof of this is the fact that there have been societies that didn’t have money, such as the Inca Empire or the hunter-gatherer human societies (The Ascent of Money, Niall Ferguson).

Even after the use of money was normalized within society, its form has changed considerably and frequently throughout history.

An example of this is the fact that, although today it’s common that governments are in charge of issuing money, it hasn’t always been the case. As Nick Szabo shows in this blog post, there have been several forms of non-governmental money throughout history. In fact, before the Civil War, most of the paper money in circulation within the United States was privately issued.

The following images (which I’m copying from Nick’s post) are some examples of the kind of non-governmental money that existed during that period and which circulated for centuries. Specifically, one is a banknote issued by a private bank in Indiana and the other one is a copper coin issued by private merchants in England.

Boone County Bank note, Lebanon, Indiana 1858. “During this era, the U.S. had no central bank and paper money was issued by a variety of private banks. Some were even issued by manufacturing and retail companies. This money was backed by gold, silver, real estate, stocks, bonds, and a wide variety of other assets. You can no longer cash them in, but they are now worth often substantial sums as collectibles…the note designs were more varied and creative than modern money and were remarkably free of politicians’ faces.” (Source)

Anglesey & Mines druid half-penny, England, 1788. “From 1787 to 1797, private merchants and industrialists issued 600 tons of custom-made ‘commercial’ copper coin, which was more copper coin than the Royal Mint had supplied during the previous half-century.” (Source)

As can be seen, in addition to whom issued the money, its form also varied. Among the banknotes, for instance, the way in which they were backed varied; while some were backed by a variety of different assets, others were backed only by silver or precious metals. Between the coins, on the other hand, their weight and material varied.

Even more recently, in times of governmental money, its form has changed considerably.

Before the current monetary system, for instance, a different system known as the gold standard was in place. The basis of that system was a “commitment by participating countries to fix the prices of their domestic currencies in terms of a specified amount of gold. (Source)” Such currencies, in fact, could be freely exchanged for gold at the established rates. In other words, they were backed by gold. The period between 1980 and 1914 was known as the classical gold standard. By that time, most countries had adopted a gold standard.

The gold standard, however, broke during the First World War, as some countries opted for inflationary monetary policies and stopped backing their currencies with gold (Source). Afterward, between 1925 and 1931, a new gold standard (with certain adjustments) would be implemented. However, in 1931 Britain would abandon it in response to massive gold outflows (Source).

Some years later, from 1946, most countries would begin operating under the Bretton Woods system. This system, which was a further modification of the gold standard, consisted in a multilateral monetary system in which the value of the dollar was fixed to a certain amount of gold, and the value of other currencies was fixed to the dollar (Money, Steve Forbes). “Persistent U.S. balance-of-payments deficits steadily reduced U.S. gold reserves, however, reducing confidence in the ability of the United States to redeem its currency in gold. (Source)” Thus, in 1971 President Nixon announced that the U.S. would no longer redeem its currency for gold, marking the end of the gold standard era (Source).

Since then, the monetary system that has prevailed is the one we currently know, in which currencies are not backed by anything and in which the exchange rate between different currencies fluctuates on a daily basis.

With the previous reflexion, I want to highlight three points:

1. That money is a human invention and as such, can be improved upon.
2. That throughout history monetary systems have tended to be unstable and can change quickly.
3. That the current monetary system is relatively new.

These three points, in turn, allowed me to consider the possibility of new monetary systems; of new forms of money. They are a necessary conceptual background for considering Bitcoin seriously.

The relativity of value

As with the nature of money, the relativity of value is another key concept worth exploring in the path to understanding Bitcoin.

I’ve always been fascinated by this concept. Its counter-intuitive nature and its implications for what we believe in can be far reaching.

To illustrate the idea of the relativity of value, let me begin with the story of the lobster.

It turns out that, to my amusement, even though the lobster is considered one of the most exquisite and exclusive dishes in the world, it wasn’t always the case. In fact, less than a century ago the lobster was considered the “cockroach of the ocean” and was food for the poor, servants, and prisoners (yes, it was served in prisons). As Daniel Luzer puts it:

If today’s lobster wears a top hat and an opera cape, 80 years ago he was wearing overalls and picking up your garbage. Lobster is a self-made creature, and quite the social climber.

How did this happen? How did the cockroach of the ocean become the main character in the world’s most exclusive banquets?

In one way, it’s a story about supply and demand. “Lobsters were so abundant in the early days — residents in the Massachusetts Bay Colony found they washed up on the beach in two-foot-high piles — that people thought of them as trash food. (Source)” This was probably amplified by the fact that the lobster was an unknown (odd-looking) animal at the time. In this sense, the prevailing conditions created a cycle in which low demand for lobsters guaranteed their abundance and, in turn, their abundance made them look like trash, promoting the low demand.

It’s worth highlighting, however, that it wasn’t a matter of taste; it was a matter of perception. The fact that the lobster was perceived as trash made it trash in the eyes of the residents of the Massachusetts Bay Colony. And, in turn, it was its abundance (and what it meant: that nobody wanted it) that made it look like trash.

An experiment done at the time corroborates this. When railways started to proliferate across the United States, certain railroad managers decided to take advantage of the fact that their passengers didn’t know what lobster was, to offer it as an exotic dish within their trains (Source). The result: passengers loved it. Since then, its consumption began to get popular across the U.S. Even though it wasn’t immediately considered high cuisine, by the 1850s it was already being served in some restaurants across the country.

This amazing experiment shows the importance of perception when valuing the lobster. While those who knew of its abundance considered it trash, those that didn’t know anything about it were intrigued by its taste.

Its elite status, however, would take some time to develop. It wouldn’t be until after World War Two that the lobster would begin to be considered an exclusive dish, as it became popular among movie stars and millionaires.

This peculiar story takes Daniel Luzer to conclude the following:

If the peer behavior around the product changes, so too does our appreciation of it. Lobster might seem to taste better to us because it’s so expensive.

I completely agree with him. If you don’t believe so, imagine the following: instead of being scarce, we live in a world in which diamonds are as abundant as sand; you can find them everywhere. Do you think their price would be the same? Do you think women would still dream about them in that scenario? Probably not. The fact that makes diamonds so crave-worthy is the fact that they’re expensive; the fact that they’re scarce.

The relativity of the value of money

In the same way, as value is relative in relation to what we eat, it’s also relative in relation to money.

Even though we don’t necessarily perceive it, the value of money changes constantly through time. It’s because of this that prices of goods and services tend to increase year after year. In the background, what’s really happening is that the money we’re using is losing value through time. In other words, what changes year after year isn’t the goods and services we consume, but the money we use to buy them, which tends to be worth less each year.

This phenomenon is known as inflation and, at risk of over-simplifying a complex topic, happens because of the tendency of there being more and more money chasing a limited amount of goods and services within the economy.

The next image, which shows the value of the dollar throughout the years, illustrates this phenomenon in a clear way.

Source

As can be observed, the dollar has lost more than 90% of its value since 1910. This has happened, mostly, as the result of the dynamic mentioned previously, in which the amount of dollars chasing a limited amount of goods and services has tended to increase. Even though it doesn’t cover the whole period, the following graph helps visualize this phenomenon since the 1980s.

M2 is a measure of the quantity of dollars in the economy.

It’s worth noting that the dollar has been the strongest currency during that period. Other currencies’ value graphs should look much worse.

Now, this is only one part of the analysis. The other part corresponds to the relativity of the value between one currency and another one: the exchange rate. As was previously mentioned, under the current monetary system the exchange rates between different currencies fluctuate freely across time. The following graph, for example, shows how the value of the currencies of Argentina, Venezuela, and Turkey has changed in relation to the dollar during the last years.

Source

Even though these currencies represent special cases because of their relative performance against the dollar, they’re not isolated cases. In fact, just this year multiple currencies have lost significant portions of their value against the dollar, as the following graph clearly illustrates.

Source

The previous analysis not only shows the relativity of the value of money across time but also its instability. Even though it may seem surprising, this is a common characteristic of the current monetary system.

In regards to the current monetary system, I’d like to make another annotation to highlight just how strange and unstable it is. This comment isn’t original; I heard it for the first time from Wences Casares in this podcast (which is worth listening to).

Even though today we have an independent international metric system that allows us to compare measurements across the world, no such thing exists for money. In other words, there’s no international standard to measure the value of money across the globe (or at least not an independent one, like the metric system). Today, for instance, if you want to know how much is a Colombian peso worth in Turkish liras, you first have to convert the peso into dollars (which is a country’s currency), and then, the dollars into liras. You may say the dollar is the international standard of measure. However, the difference with respect to the metric system is that the dollar is a country’s currency. It’s not independent. It’s as if the metric system had an owner: it’s strange and disorganized.

It’s worth noting that this hasn’t always been the case. As shown previously, during the gold standard such international standard was in fact performed by gold. Being that gold is a natural (independent) element, such a system was much more like the metric system.

Let me conclude this section highlighting the most important points regarding the relativity of value (with Bitcoin in mind):

1. The importance of scarcity (or abundance) when valuing things (be it a lobster or dollars).
2. The fragility of our reality (or our beliefs) and the difficulty to appreciate certain things when they go against popular belief. This is evident from the lobster story.
3. The inherent instability and disorder of the current monetary system.
4. The tendency of governments to print higher and higher quantities of money and, in turn, destroy the value of their currencies throughout time.

As I mentioned at the beginning of this piece, Bitcoin isn’t an easy subject. For me, the concept didn’t immediately make click. I, in fact, had heard about Bitcoin since 2013 when, exploring the investments of the Winklevoss twins, I found out they were investing in Bitcoin and related companies.

In spite of that, it wasn’t until 2017, when I decided to study and consider Bitcoin in a serious way, that it made click for me. Since then, I haven’t turned back.

The concepts within this article were a fundamental part of my process. They made me open to the possibility of Bitcoin. I hope they’re as useful to you.