Bitcoin billionaire and venture capitalist Chamath Palihapitiya thinks that cryptocurrencies counter capitalism and could help create a better financial future for the world.
On a new episode of the All-In podcast, Palihapitiya makes the case for crypto assets and decentralized finance (DeFi), saying that crypto is already dramatically changing the way capital is allocated.
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“It destroys capitalism. If you think about what capitalism is, it’s not just a return on investment, but it’s the tonnage of dollars. So anyone who’s a big investor here – you’re putting more and more dollars in for more and more dollars out.
That’s the pressure. These guys are under enormous pressure to get tonnage of dollars through the system in a productive way. These guys are at the forefront.
But when you look at most of the projects on Solana [SOL], they’re seeded with a few million dollars, and these are $60-$80 billion market cap projects. And so, I don’t know how capitalism survives in that world.”
Palihapitiya says the autonomous nature of crypto assets, as well as crypto-based systems of governance that simply rely on code instead of human beings, are another game changer.
Governance goes completely out the window. Because you’re essentially replacing a set of norms that we’ve all agreed to about what a company is. It’s an LLC or C-Corp that is incorporated with laws. There’s recourse for you, you can go to these places and sue them. Now it’s a DAO (decentralized autonomous organization).
It’s a bunch of rules written in a blockchain. ‘Here’s how it all works, here’s how I make my HR decisions. Here’s this, here’s that.’ And then you basically decompose everything into a service where it’s recursive. You cannot build with me unless you make yourself buildable to others.”
The end result, according to Palihapitiya, is a digital transformation that will reshape the nature of capitalism in a remarkably positive fashion.
“When you add all these… things together, to me it’s the most incredibly, positively disruptive force we have seen. I think it will destroy wealth. I frankly couldn’t give a fuck and I think it’s better for the world.”
I
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Throughout history, there has been a cyclical phenomenon characterized by Neill Howe and William Strauss as the four turnings.1 The basic premise of the theory is that civil unrest and major war is cyclical and occurs about every four generations. This is due to the fact that, by the time we reach the fourth generation post-war, society is simultaneously in a state of desiring change yet far enough removed from the atrocities of war that they end up repeating the mistakes of those four generations before them.
As it stands, we are in the fourth turning, the final saeculum before the cycle resets. What’s unique about the fourth turning is that it has historically been an era of destruction, often involving war and revolutions. Based on this theory, it is no wonder we are seeing social unrest. It doesn’t take much browsing of social media or news to see that people want change. People are starting to speak out about the issues within our society: wealth inequality, rising house prices, increasing cost of living, systemic malinvestment and the great concentration of monopolies.
However, as with anything, it can be difficult to decipher the root cause of the issues we face. The millennial generation feels disconnected as it will be the first generation in history to be poorer than its parents.2 The middle class is fed up as it slowly erodes away while asset prices become more unobtainable.3 This unrest is resulting in people voicing their opinions and looking for a way out of this mess. As it stands, capitalism and its lack of governance appears to take the brunt of the blame. As a result, in recent years, people have been more drawn to regimes such as communism or socialism to promote liberation and equality within society (40% of Americans have a favorable view of socialism, up from 36% in 20194). But, this begs the question, is a shift in regime really the best course of action? And is capitalism really to blame?
Before we can answer these questions, let’s first define the various economic systems:5
– Capitalism: “An economic and political system in which a country’s trade and industry are controlled by private owners for profit, rather than by the state.”
– Democracy: “A system of government by the whole population or all the eligible members of a state, typically through elected representatives.”
– Socialism: “A political and economic theory of social organization which advocates that the means of production, distribution, and exchange should be owned or regulated by the community as a whole.”
– Communism: “A political theory derived from Karl Marx, advocating class war and leading to a society in which all property is publicly owned and each person works and is paid according to their abilities and needs.”
From the outset, one could easily conclude that capitalism is incredibly flawed in relation to communism, socialism and democracy as it appears to be focused on private enterprise and profit. On the contrary, communism, socialism and democracy seemingly value the people, liberation and equality. However, if we remove democracy from the equation and take what we have learned from history, we realize that the communist and socialist facade of liberation, equality and a focus on the people could not be farther from the truth. Here are a few historical examples:6
– Mao Zedong, China, 1943–1976 (Socialism): 70,000,000 died by mass murder and government policies (largest death count in history).
– Joseph Stalin, Soviet Union, 1922–1952 (Communism): 28,000,000 died by war genocide and famine (second largest death count in history).
– Adolf Hitler, Germany, 1933–1945 (Socialism): 12,000,000 died by war and genocide (third largest death count in history).
– Kim Jong-il, North Korea, 1993–2011 (Socialism): 2,500,000–3,500,000 (10–19% of the population) died during 1990s famine in part caused by government policies.7
– Pol Pot, Cambodia, 1975–1979 (Communism): 1,700,000–1,900,000 (21–24% of the population) died by government policies and famine.8
– Provisional Military Administrative Council(Communism), Ethiopia, 1974–1987: 1,200,000 died from famine in part caused by government policies.9
It quickly becomes apparent that many of the major genocides, famines and deaths caused by war were all under communist and socialist regimes. Are these regimes really creating a happier and high quality of life economy?
Let’s look at the chart below (sorted by the happiness index, with the happiest nations at the top). There is clearly a correlation between democracies, happiness, freedom, quality of life and currency purchasing power.
2020 Countries Sorted By Happiness Rating Chart10 11 12 13
What is it about communism and socialism that leads to such atrocities, and why do they tend to fail?
Supply and demand: One of the major pitfalls of communism and socialism is that creating a centrally planned economy with the goal of equality, influences the labor force and destroys the natural forces of competition. Inadvertently, this distorts supply and demand. What is forgotten is that through supply and demand, we gain valuable economic insight that allows our economy to error correct, grow and innovate.
Inadequate knowledge and a concentration of power: Within communist and socialist regimes, society tends to rely on the knowledge and experience of an individual or select group of individuals. The central planners believe they understand what is needed to move a country forward. The fallacy in this belief is that humans have many natural biases, such as the need to maintain and secure power, wealth and safety for themselves, their offspring and those closest to them. The result of these biases is that both communism and socialism are prone to authoritarian and totalitarian rule. Once the central planners start to accrue power, they don’t tend to let it go easily. Ultimately, this has led to some of the worst inequality, human rights abuses and social unrest in history. Instead of centralizing power, we should be taking advantage of the population’s collective knowledge.
Suppression of innovation: Communism is built on the belief that we should have a classless society. Although this may appear to be a step forward, diversity among our population prohibits this from playing out as intended. Our society is composed of family-oriented, entrepreneurial, sport-focused and business-minded individuals and we must allow them to explore interests that resonate with them. People are motivated by the belief that they will benefit from the fruits of their labor and this is what creates the perfect breeding ground for creativity and innovation to flourish. When we centrally plan, remove private property rights, and dictate individuals’ careers based on their skills and knowledge, we disincentivize individuals to think outside the box in an entrepreneurial and innovative manner.
Furthermore, innovation doesn’t tend to come from large centralized powers but rather it emerges on the fringe. It is through the free flow of information that creativity and innovation thrive. When we restrict competition and silence people, we end up severely inhibiting innovation and creativity, as this prevents factual, non-mainstream data from percolating to those who can use this information meaningfully. Humanity should promote creativity and innovation as this is how we will solve poverty, climate change, pollution and more.
For these reasons, in the long run, communist and socialist regimes have tended to break down and have led to some of humanity’s worst atrocities. However, no economic system is entirely flawed; otherwise, we wouldn’t see communism and socialism initially implemented. On paper, communism and socialism have many benefits, as both aim to promote security and equality. Socialism, in particular, has given the world universal healthcare, education and welfare. While communism, when effectively implemented, assures that you will have employment when you finish school and eliminates food insecurity. Every economic system has its pros and cons. Thus, we must implement what works, while admitting to ourselves what doesn’t and adapting accordingly.
Where Do Democracy And Capitalism Fall In All Of This?
It can be easy to pin capitalism as the cause for the issues we face due to the fact that all of these issues revolve around the monetary system, and is it not money that drives wealth inequality and capitalist monopolies? However, if we objectively dig a little deeper, capitalism has unfairly been the scapegoat for everything the government doesn’t want to be held accountable for. The reality is that the victims of so-called capitalism are, in fact, the people who have lost capitalism due to increasing governance, regulation and control. In other words, the more control government is given, the more these issues are exacerbated.
The Misdirection Narrative
The notion that our societal and economic issues stem from the government may initially be difficult to believe. The mainstream narrative consistently frames capitalism for the corruption, greed among private corporations, and detrimental monopolies within our economy. However, this is all just a narrative pushed as a form of misdirection. This narrative gives the general population something to blame for the issues we are facing.
Why is this anti-capitalist narrative pushed? The government doesn’t like to relinquish control. You don’t have to spend much time looking through history books to conclude that governments have a lust for control and rarely, if ever, give it up. Therefore, it is not in the government’s best interest to attribute the issues within our economy to its own decision-making. It would only further destroy its population’s faith in government. To better understand this, let’s delve into the various issues we are facing.
Rising House Prices And Cost Of Living
Many tend to attribute increased cost of living to the big corporations raising prices and the escalating house prices to the benefactors of capitalism buying up property. However, the reality is that these are issues with our monetary system. The problem is that the government controls the monetary system via the Federal Reserve and the U.S. Treasury. This gives them some significant benefits, such as regulating who can and can’t use the currency, hidden taxation via inflation and financial repression, and the ability to self-fund without having to offer value (such as it would in a free market capitalist economy). We see this abuse of the monetary system in plain sight. In the last 18 months, 37%14 of all dollars in existence have been created, and the Federal Reserve has purchased 76.4%15 of federal debt. They no longer need to rely on income generated through taxation but rather to just purchase their own government debt.
Ultimately, this allows the government to act in its own self-interest, directing capital to where it feels necessary, which seems to be toward growth at the expense of the economy. It does this via inflation, which is the suppression of interest rates and the injection of capital into our economy to stimulate growth, spending and consumption. The by-product of this tactic is an increase in the money supply, which leads to a rise in consumer prices, cost of living, house and asset prices, and inequality.
Monopolies
Monopolies, in a general sense, are not detrimental to society. They become harmful when they stifle growth and innovation by suppressing competitors in an attempt to maintain their monopolistic position. In a free market, a monopoly is in its position because it adds value to society. Individuals have chosen to purchase their products and services, which allows them to grow and expand. When they stop offering value and/or a superior product or service comes to market, these monopolies are naturally replaced with the newest technology and services.
Unfortunately, this is not the case in our current system. Due to the lobbying environment among most democratic nations, monopolies have the ability to donate large sums of money to politicians and those in power to sway regulation to their benefit. This regulation aids these monopolies by increasing entry barriers and thus reducing competition. Harmful monopolies are not an issue of capitalism, but rather an issue of giving the government too much control and allowing private corporations to influence regulation.
Malinvestment
As people become overly comfortable that the Federal Reserve will intervene during times of stress, we see a rise in excess borrowing and speculative leverage in an attempt to maximize returns. This excess borrowing has two main negative side effects:
1. Excess borrowing creates a surplus of capital in the system. In an attempt to find a home, this capital finds its way into higher risk malinvestments, which leads to amplified fragility in our economy. What would generally be considered a benign market event instead triggers much greater volatility and systemic problems.
2. A zombie company is one that is unable to support itself financially.16 This signifies that the product or service the business offers either does not have enough demand or that the business has been fiscally irresponsible and unable to service its debt. This business should, therefore, restructure or dissolve. With the Federal Reserve backstopping the economy and making it cheaper and easier to access capital, you increase the number of zombie companies in the economy. We should allow the natural life cycle to play out rather than propping up unsustainable companies. When a new business has to compete with an ever-increasing number of zombie companies, it becomes ever more challenging for that business to succeed and prosper. Instead of focusing on innovation, the business must use a portion of its resources to compete. As of July 2020, 19% of listed companies in the U.S. are zombie companies, and this number is rising.17
It should now be evident that the issues we face within our economy today are not to do with capitalism but rather the opposite. They are a by-product of government intervention and control.
What Needs To Change?
No economic system is perfect. Therefore, it is important to avoid getting bogged down analyzing which system is best. Instead, we should focus on what’s within our control to create an economy that prioritizes its people, promotes innovation and encourages creativity. To do so, we must first look at what must change in our current part-democratic, part-capitalistic system:
Monetary system: As should now be apparent, to reduce the centralization of power, the negative by-products of inflation and systemic malinvestment, we must separate the monetary system and the government. Doing so removes the government’s controlling capabilities, ensuring they act as a service provider with the population’s interests at heart. If the government is not acting in the best interest of the population, it will not receive capital in the form of taxes and will be unable to fund itself. Additionally, removing the monetary system from the clutches of government would allow a monetary system chosen by the people to emerge, one that is not corrupted by those in power and allows the true deflationary state of the world to surface.18 As Aaron Segal concisely states, “deflation is a measure of success in creating economic value as innovation creates more for less.”19
Transparency: Nations fail when there is a lack of trust in government, resulting in coups and revolutions. The fastest way to break trust within a nation is to remove transparency. One of the major flaws we face today is a lack of transparency. If we promote transparency within our economic system, we can rebuild trust amongst the population and the government. This will help drive the economy forward by reducing our wasted productive energy spent fighting amongst ourselves.
A Potential Solution
It can be difficult to separate democracy and capitalism, as they have generally been intertwined throughout history. One could go as far as to say that we have never seen a true capitalism-based economy. This makes it challenging to pinpoint the benefits democracy has brought to the table and likewise for capitalism. However, if we want to promote innovation, productivity, sustainable growth and freedom moving forward, it is in our best interest to adapt as an economy and take on benefits from the various regimes:
Socialist welfare/healthcare/education: We live in a world of inequality. Individuals enter this world disadvantaged, and we have unforeseeable events that take a toll on our lives. Whether this is on a monetary, health or educational level, it is a fact of life. Thus, we must have access to resources that allow us to feel a part of society and obtain the necessary assistance to grow and thrive. With this in mind, the best option would be to adopt the socialist welfare, healthcare and education system, ensuring everyone has access to these core amenities.
Decentralized democratic decision-making: Democracy is essential to ensuring that the general population has a say in political decision-making. However, we must ensure that this doesn’t result in a concentration of power, lack of transparency or the potential for bad actors. To promote transparency and take advantage of the collective knowledge, we should focus on the decentralization and dispersion of centralized government power down to the lower state, municipal and individual levels. This would ensure that more people would have a say in how our country is run and that regulation is upheld.
Capitalist free market: The capitalistic free market is an incredible source of creativity and innovation. It rewards individuals for putting themselves on the line and bringing their ideas to life. Additionally, free market capitalism promotes natural supply and demand, allowing us to extract crucial economic information, error correct more effectively and thrive as a nation.
Bitcoin
How can Bitcoin play a role in all this? Bitcoin offers a way to bridge democracy and free market capitalism by providing a true decentralized currency that is:
– Permissionless: No one is excluded from using bitcoin. There is no gatekeeper deciding who can and can’t use it.
– Open-Source: Bitcoin’s source code is open-source, allowing anyone the ability to read, propose a modification, copy or share.
– Pseudonymous: Since no ID is required to own and use bitcoin, this ensures privacy for individuals.
– Fungible: All coins are treated as equal and should be equally spendable.
– Immutable: Confirmed blocks/transactions are set in stone and, therefore, cannot be changed at a future date.
– Fixed Supply: With a fixed supply of 21 million coins, bitcoin is proving to be one of the best stores of value due to its inability to be devalued through supply expansion. This is key to providing accurate supply and demand data.
Bitcoin has the potential to remove the monetary system from the clutches of the government, allowing us to operate a true capitalistic free market. This would enable us to obtain accurate supply and demand information, allowing our economy to grow, innovate efficiently and error correct. Bitcoin would also give the general population security, knowing that their hard-earned savings will not fall victim to inflation.
Additionally, Bitcoin gives us a great example of the power of decentralization. If we can take what we know from Bitcoin’s decentralized blockchain, we can greatly increase transparency within our economy. Two areas which may benefit the most are:
Government: By implementing a decentralized blockchain within the government, we can increase transparency and remove the potential for self-interested bad actors. Furthermore, promoting decentralized transparency would allow everybody access to accurate, immutable consensus data, decision-making and economic information. That way, individuals and the government could better use this information to innovate and progress.
Decentralized Autonomous Organizations (DAOs): Just like other economic systems, free market capitalism still has the potential for bad actors. By using blockchain technology, we can build the next generation of organizations using the DAO framework based on open-source code. Furthermore, without a typical management structure or board of directors, we are able to operate decentralized organizations. This gives investors a real say in the direction of the organization and gives the public transparency regarding the organization’s goals and motives.
Conclusion
It should now be clear that many of the reasons individuals are pushing for communism and socialism are not due to flaws in capitalism but rather increasing governance, regulation and control. Looking back throughout history, if we give way to these propositions, the consequences may be detrimental — the fallacy to consolidate and centralize power has led to some of mankind’s darkest days.
Instead, we should step back and look at capitalism and the other economic systems from a more holistic viewpoint. Let’s take the welfare/healthcare/educational support system from socialism, implement democratic decision-making, and give more power back to the people to let free market capitalism run its course. By doing so, we may be able to resolve many of the issues we currently face.
Lastly, instead of pointing fingers at capitalism, we should be educating people about the benefits that it has brought to our economy in the form of increased innovation, private property, privacy and human rights.20 Furthermore, we should be trying to better integrate new technology such as Bitcoin into our ever-evolving economy.
Humanity is in the middle of a turning point where it is shedding much of the old inefficient technology and practices and making room for the new era. With this in mind, we should be focusing on what matters. Let’s come together and build the economy we want to see tomorrow instead of directing our energy toward each other in the form of aggression and criticism. As Thomas Jefferson once said, “I predict future happiness for Americans, if they can prevent the government from wasting the labors of the people under the pretense of taking care of them.”
This is a guest post by Sebastian Bunney. Opinions expressed are entirely their own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.
Endnotes
1 Howe, Neill, and William Strauss. “The Fourth Turning.” Crown Publishing Group, 1996.
2 Lowrey, Annie. “Millennials Don’t Stand a Chance.” The Atlantic, 2020,
3 PEW Research Center. “Trends in Income and Wealth Inequality.” PEW Research, 2020,
https://www.pewresearch.org/social-trends/2020/01/09/trends-in-income-and-wealth-inequality/. A
4 YouGov. “Fifth Annual Report On U.S. Attitudes Toward Socialism, Communism, and Collectivism.” Victims of Communism, 2020, https://victimsofcommunism.org/annual-poll/2020-annual-poll/.
8 Kiernan, Ben. “The Demography of Genocide in Southeast Asia: The Death Tolls in Cambodia, 1975-79, and East Timor, 1975-80.” Taylor & Francis Online, 2010,
Bitcoin embodies Schumpeterian creative destruction. Bitcoin also behaves like a physical natural resource, with unique differences that make it a driving force for effecting fundamental change, much like gold, oil or electricity has done.
Bitcoin goes through periodic cycles of varying lengths that inspire a creative rejuvenation of its ecosystem with new ideas and innovations at various timescales and magnitudes. Here we will apply the idea of a Schumpeterian business cycle to Bitcoin and construct a Schumpeterian Bitcoin cycle based on three componential waves: a multi-decade Bitcoin Kondratieff cycle; a Bitcoin Juglar cycle that is shorter than a decade; and a Bitcoin Kitchin cycle that corresponds with the halvings.
Associated with these sub-cycles are three ratios that capture their logic: stock-to-flow (S2F), installed capacity-to-capital investment (IC2CI) and inventories-to-sale (I2S).
Joseph Schumpeter
1. Creative Destruction
Joseph Schumpeter would have loved Bitcoin. He would have seen in Bitcoin a living representation of his theory of capitalism, so often quoted but rarely understood. Creative destruction is the process by which capitalism continually rejuvenates itself. It is what drives markets forward and allows them to be constantly refreshed with new ideas that destroy extant structures and erect better ones in their stead.
There are countless elements in Bitcoin that structurally instill the process of Schumpeterian creative destruction in its ecosystem, making it an excellent model for the cycles of capitalistic rejuvenation that formed the basis for Schumpeter’s theory of economic growth. For instance, consider the process of the halving of block rewards. Every 210,000 blocks, Bitcoin forces a creative destruction of itself, urging its participants to either reimagine their competitive edge, seek hidden efficiencies and eradicate waste or risk being left by the wayside. Bitcoin’s worth is rooted in the intrinsic value of capitalism, liberated one cycle of creative destruction at a time.
If there is creative destruction inherent in Bitcoin, then where are all those new products that eventuate when extant markets are destroyed by new ideas? Wasn’t that Schumpeter’s point after all?
The answer is simple. Bitcoin evolves into a new product — a new version of itself — with each cycle of creative destruction. Since we are so used to thinking of a bitcoin as immutable, we tend to look past this essential characteristic feature it possesses to reinvent itself.
Bitcoin started off as electronic cash native to the Internet, but has since become many things besides. It has become the most sound platform for the definitive settlement of contracts; it has become a savings account for individuals and corporations; it has become a useful tool for international remittances; it has inspired an ecosystem of financial instruments, cryptocurrencies and much else. None of these were imagined as core features for Bitcoin in 2008. Yet, with each cycle of creative destruction, Bitcoin was reimagined.
2. A Natural Resource With A Difference
Bitcoin can usefully be examined as just another exhaustible natural resource that has held the power to alter the course of human civilization, such as gold or, even more aptly, crude oil. Crude oil underwent several cycles of creative destruction since its discovery in antiquity. In its long history, crude oil has at various times been used predominantly for heating and cooking, asphalt paving, lighting, lubricating and powering machines, transportation, plastics, aviation and so on.
Of course, there are key differences between Bitcoin and natural resources, but the similarities are just as interesting.
Bitcoin can be imagined as a physical field of exploration where prospectors dig for coins. The field has the following characteristics.
First, the total yield from the field is fixed at 21 million coins, and no matter how hard the prospectors may dig, the field simply won’t yield any more coins. All prospectors know this to be true in advance, which puts a very definite terminal point in time to their activities.
Second, prospectors know with certainty that it will get increasingly harder to find more coins as they dig. That’s because they also know that this field cannot be gated and thus prospecting cannot be regulated. So prospecting for coins will take the form of a “gold rush”; extraction of the in situ, unmined coins will be an extremely competitive activity.
Well, it will almost certainly keep getting harder. The only way in which it will ever get easier for any given prospector is if, for some reason, his rivals decide to reduce their efforts. If that happens, then for a short time the prospector gets just a bit more of the field to himself to mine for coins using his current digging equipment. Before long, though, his rivals observe his obvious fortune and come rushing back in. This squeezes him back to a smaller area on the field. Now he simply must invest in better equipment if he wishes to outcompete his rivals.
Third, the fiercer the competition, the less space each prospector will have in the field. To extract coins he will need to try even harder than before. It gets exponentially harder for him to dig deeper, and he has to bring in more and more sophisticated digging equipment to extract coins. He started off with a spoon, upgraded to a spade, then an excavator, then a vertical drill and so forth.
We paint this picture merely to underscore the point that Bitcoin is a rare and non-perishable natural resource like platinum, gold, iridium or even rhodium. It is a singular kind of natural resource even among that illustrious group, but it is one all the same. And yet, two things about Bitcoin make it a rather exceptional natural resource.
First, since available market supply is known to be fixed and the extraction rate asymptotically approaches zero, future demand is met increasingly with already obtained inventories and decreasingly through new production; until roughly 2140, after which all demand must be sufficed by a globally fixed inventory alone.
Thus, hoarding Bitcoin in inventories is rational even before all its possible uses have been discovered. Imagine if the costs of storing in inventory were similar for gold and oil to what they are for bitcoin. Now consider how we would have behaved if it were known with 100% certainty that, in the year 1850 BC, gold, or for that matter, in the year 1850 AD, crude oil had universally fixed and fully extractible supplies and that almost 90% would be extracted from all their in situ locations within just 15 years of their discovery. Hoarding would have been so frenetic and all-consuming that history books the world over would have to be rewritten.
Second, being digital, bitcoin is divisible and additive at virtually any scale and at a fraction of the cost of any physical natural resource. This makes bitcoin more “malleable” than any other natural resource, which permits its use to span markets — from micro to macro. The immutable finality of its settlement layer permits Bitcoin to function as essential macro infrastructure; the concomitant mutability that its higher layers enable permits it to function in specialized markets where contractual elasticity is required.
With this premise of bitcoin as a non-perishable natural resource, we now wish to argue that bitcoin’s market price is governed by a set of nested cycles that have been well-known to natural resource economists since at least the 1920s and were used by Schumpeter in his theory of business cycles. Their use fell out of favor in mainstream economics because of reasons that do not apply particularly well to bitcoin and, consequently, there is much that we can learn by using this framework to examine the bitcoin cycle.
3. The Three Sub-Cycles
Schumpeter identified three cycles of different lengths as the basis for his theory of business cycles. Each cycle had distinct drivers and horizons, but they tended to have confluent peaks and troughs as they formed an overarching narrative for capitalistic growth; together the three cycles became the components of an overarching Schumpeterian Cycle. The sub-cycle with the shortest length in his overall three-part cycle was the Kitchin cycle, which he estimated at about 40 months, though empirically it has been measured to be as long as 60 months. The Juglar cycle was much longer, with a period of roughly 10 years (and between 7–11 years in the literature). The longest was the Kondratieff cycle (or K-wave) with a length of approximately 50 years.
What broadly drives a Schumpeterian cycle together is entrepreneurial activity and innovations interacting with one another in a grand cycle. As a suite of innovations are exploited by entrepreneurs an economy improves from a state of depression toward a state of improvement. Once the extant technology’s benefits have been leveraged at the peak of prosperity, the state of the economy turns towards recession and finally back into a state of depression.
Let’s take a closer look at each of these cycles, and explore their connection to Bitcoin.
A. The Bitcoin Kitchin Cycle
The Kitchin cycle stems from firms with fixed capital constraints that must contend with lags in information on market conditions. During the upward swing in the business cycle, firms ramp up production and enjoy super-normal profits as the market swings into prosperity. Firms bring their fixed capital use to full-employment levels and eventually overwhelm the market with excess supply. This depresses prices, tipping the market over into a state of recession. Firms respond by building up their inventories. Production gets scaled back and, once the market is back into equilibrium, the cycle is complete.
The process that drives a Kitchin cycle has been noticed in the context of agricultural commodities (in fact, it is often called the hog cycle), and led to the development of the Cobweb model to explain oscillating prices. One of us has discussed this model in the context of Bitcoin before. It is also observed in markets for hard commodities, including metals.
You might note the Achilles’ heel in the argument, if you are even casually abreast of neoclassical economics. Besides the obvious criticism of undue determinism in the length of the cycle, it minimizes the role of adaptive expectations. Firms ought to learn from the markets more effectively and not get suckered into an endless cycle of chasing demand with overproduction. Determinism is, however, built directly into Bitcoin. An average time target for blocks at 10 minutes/block over 2016 blocks is a predetermined environment variable for Bitcoin and, while miners have thus far outstripped this rate marginally, the date for the next halving can be approximated. While network difficulty and hashrates vary over the course of the cycle, and the latter is affected by market conditions on costs of production and prices, duration of the halving cycle length is known.
A Bitcoin Kitchin Cycle roughly equal to the halving cycle (44-48 months) makes sense. The supply side — miners and, to a degree, even exchanges and hodlers — is incentivized to supply more to the market as prices rise by increasing their hashrates and/or drawing down their inventories. When prices fall, miners scale back their hashrates and add to their inventories if they can or, if they cannot cover their fixed costs, they scale back or even exit.
Thus, the ratio of inventory to sales is crucial to a Bitcoin Kitchin Cycle. An inventory is a stock of a given product that the producer has access to and sales are the flows out of inventories. As selling pressure diminishes and inventories are increased, an increase in the I2S ratio marks the end of the recession phase and the beginning of the improvement phase for the following Bitcoin Kitchin cycle. The ratio falls as the cycle turns from the height of the phase of prosperity and towards the depression phase.
B. The Bitcoin Juglar Cycle
The role of innovation and investment is far more crucial in the longer duration of the Juglar cycle, where demand overwhelms the available supply during the upward phases of the business cycle so thoroughly that merely the full employment of existing physical capital is insufficient.
The pace of research and innovation increases to effect a change in the nature of new investments made by firms. Entrepreneurial effort in identifying key innovations and deploying them for such new investments takes a longer time than is permitted by the Kitchin cycle; similarly, during the downward phases of the business cycle, declining demand affects production with a greater lag than in the Kitchin cycle because new investments, once made, cannot be undone within a shorter time frame.
A period somewhat shorter than two halvings, roughly 7–8 years, seems the most natural length for a Bitcoin Juglar cycle. The first Bitcoin Juglar cycle began in 2009 and completed at the end of 2015, taking Bitcoin mining through an entire innovation and reinvestment phase from CPUs to the first broadly available ASICs. Thus, we are now approaching the end of the second Juglar cycle, perhaps sometime in 2024, and the story of this cycle, we can only hypothesize, will likely be a locational reinvestment of plants in search of energy cost efficiencies from a range of sustainable energy alternatives.
Bitcoin-friendly energy companies are already building bitcoin mining facilities next to underutilized wind energy fields producing more energy than can otherwise be consumed, as well as stranded natural gas wells that would otherwise be flared or vented. In the former case, the offtake of excess energy allows otherwise unviable wind installations to remain competitive. In the latter, greenhouse gas production from flaring and venting is reduced by bitcoin mining.
The critical ratio of interest for a Bitcoin Juglar cycle is that of installed capacity/capital investment, since it is at the peak of the cycle that the IC2CI ratio is at its highest and begins declining only as installed capacity of a specific type is overwhelmed by demand and makes the need for newer forms of capital investment more clear. Hence, the impetus for the next Bitcoin Juglar cycle comes from new capacity coming online through investments in newer technologies, production methods and materials.
C. The Bitcoin Kondratieff Cycle
The Kondratieff cycle, or K-wave, is the cycle of the longest duration, at between 40 and 60 years.
The cycle emanates from a fundamental and transformative change in technology that brings about broad socioeconomic consequences, far beyond those captured by cycles of shorter lengths. The more recent K-waves identified in the literature include the age of steel and heavy engineering (1875), the age of oil, electricity, the automobile and mass production (1908) and the age of information and telecommunications (1971).
Schumpeter, much in accordance with Kondratieff’s own vision, saw the impetus for progression between K-waves to be the clustering of several key supporting innovations. The innovative entrepreneurial insight for a transformation to begin the stage of prosperity simply could not arise unless all of the requisite ideas had first been discovered.
In the context of Bitcoin, the K-waves of concern pertain to the source of “hardness” in money. Loosely, the waves appear to be the age of gold specie money (1873–1914), the age of the gold standard (1925–1973), the age of fiat money (1973–2009) and, finally, the of age of Bitcoin (2009 onwards). If the K-wave length of roughly 40 years is prescriptive, it suggests to us that there are likely going to be interesting transformations in store for Bitcoin well before the final bitcoin is mined.
At the end of the first Bitcoin K-wave, roughly in the year 2047, 10 halving cycles would have been completed and 99.90234386% of all bitcoins would have been mined, leaving just shy of 20,508 bitcoins left to be mined. The economic value of block space will naturally rise exponentially throughout this wave and, perhaps, this metric will even prove pivotal in effecting the end of the first wave. The second Bitcoin K-wave will rely on a suite of associated technologies that are either extremely nascent at this stage or even yet unimagined in order to bring about the next transformation.
Marc Andreessen’s observation, made around the time of the beginning of the first Bitcoin K-Wave, that “software is eating the world”, is relevant to Bitcoin during this cycle since “Bitcoin is eating monetary systems”. In the second Bitcoin K-Wave, however, a much larger gamut of technologies will permit us to say that “Bitcoin is eating digital economies” en masse.
The most useful ratio for the Bitcoin Kondratieff cycle would seem to be the stock-to-flow ratio that Saifedean Ammous discussed in his book and is now well-known to Bitcoin observers thanks to PlanB’s empirical work. However, in terms of annual production and net stock, of course, the S2F ratio increases as a step-function asymptotically as we approach the year 2140. There can be no variations to accommodate cyclicality.
We concede that it may well be that bitcoin will break all expectations, as it so frequently does, and give us an age of Bitcoin that has a far longer K-wave length.
However, if indeed past proves precedent and between now and when the final coin is fully mined Bitcoin experiences at least three full Kondratieff cycles of roughly 40 years in length each, we can still use a modified version of the S2F ratio to examine the phases of each cycle; to avoid confusion, we might call it S2F*.
Within each cycle, the S2F* ratio can fall below the algorithmic equilibrium expectation if we define the “flow” as bitcoin’s market velocity in addition to its production rate per unit of time alone. A possible measure for this velocity could simply be Bitcoin Days Destroyed (BDD).
Thus, the ratio for the Bitcoin K-wave becomes:
S2F* = (extracted bitcoins held in inventory)/(annual production + BDD)
S2F* becomes identical to S2F when the majority of bitcoin inventories are dormant, which is our expectation as we move from one Bitcoin K-wave to the next. In the longer run, settlements on the base layer ought to become rarer events and indicate exceptionally significant outcomes. After all, once the land grab is behind you and the citadels have been built upon it, the emphasis shifts to the bustling activity within those structures.
In Figure 1, we summarize this section and present the three sub-cycles of the overall Schumpeterian Bitcoin cycle, their associated metrics and their approximate lengths.
Figure 1: Elements of the Three-Part Schumpeterian Bitcoin Cycle
4. And, Finally, A Look Ahead
Figure 2 below illustrates the Schumpeterian Bitcoin cycle. The Bitcoin K-wave is shown in dark gray; the Bitcoin Juglar cycles are depicted in purple; and the Bitcoin Kitchin cycles, which correspond closely with the halving cycles, appear in blue.
Figure 2: Schumpeterian Bitcoin Cycle
Naturally, a dollar price as the unit of measure for the y-axis can only be taken as a very loose proxy for the various drivers of the components of the Schumpeterian Bitcoin cycle, especially considering the length of time a Bitcoin K-wave covers. However, it is worth examining a few aspects.
Towards the end of the first Bitcoin K-wave, all the cycles should converge. The idea is simply that all manner of flows out of all kinds of stocks begin to dwindle as the fundamental drivers of innovation for the next Bitcoin K-wave begin to coalesce: anew suite of technologies have arrived for Bitcoin that will become the impetus for the second Bitcoin K-wave.
Bitcoin is retained in inventories alone, and sales become rare, bringing I2S to all time highs. Capital investments dry up since the installed capacity represents increasingly untenable market propositions, driving the IC2CI ratio to all time highs. Flows of bitcoin, through mining (for obvious reasons) and from inventories peter out to extremely low levels, resulting in a stratospheric S2F* ratio. All ratios will remain relevant in the second Bitcoin K-wave, albeit at an entirely different order of magnitude.
What lies ahead is anyone’s guess…
Just like the Kondratieff waves since the industrial revolution, we should expect truly transformational innovations affecting economies and societies globally in each of the Bitcoin Kondratieff waves. Perhaps, bitcoin as the undisputed global reserve currency at the close of the first K-wave; then Bitcoin as the basis for a global digital infrastructure in the second K-wave; and, it’s hardly beyond the realm of possibility that bitcoin emerges as the basis for interplanetary transactions in the third!
This is a guest post by Prateek Goorha and Andrew Enstrom. Opinions expressed are entirely their own and do not necessarily reflect those of BTC Inc. or Bitcoin Magazine.
I know there are legal answers to this question, but that’s not really what I’m interested in. I am more interested in where and how we, as the blood-thirsty capitalist society that we are, draw the line between the market being the market and the market being manipulated.
Jill Carlson, a CoinDesk columnist, is co-founder of the Open Money Initiative, a non-profit research organization working to guarantee the right to a free and open financial system. She is also an investor in early-stage startups with Slow Ventures.
There are a few ways to think about the answer to this question. There is the free market libertarian answer, which says that whatever the market is doing must be right. There is the fundamentals, rules-driven approach, which says the market will always (eventually) revert back to reasonable multiples of the metrics that textbooks and professors have deemed to matter. And then there is the democratic approach, which says the wisdom of the crowd ought to prevail. I am not sure that we should call it wisdom, but this week the crowd certainly prevailed.
The enormous rally in GameStop equity (and the corresponding pain felt by certain hedge funds which were short the stock) represented a coup de grace for retail investors in a battle that has been waging for years.
Several phenomena have been working synergistically to bring retail traders en masse into the markets. There have been the trends that have been playing out for years: increased accessibility, thanks to entrants like Robinhood; the rise of influencer culture, in which one or a few individuals can mobilize their digital followings; ongoing disillusionment with the establishment, a theme that dates back at least to the 2008 crisis; and the internet-driven narrowing of the gap between expert and amateur that has occurred across all fields over the last decades.
Then there have been the catalysts specific to this past year. 2020 saw sports betting close down and casinos shutter. It saw a single-day stock market drawdown that forced many to question what they were doing with their 401(k)s, if not their lives, followed by an incredible rally in the face of dismal economic realities. It was the year of being forced indoors and onto screens. It is no wonder that last year smashed all records of new retail brokerage account openings.
The flood of retail investors and retail dollars has generated a new set of tensions. This came to a head this week in the coordinated buying of GameStop stock and call options by retail investors coordinated on the Reddit forum WallStreetBets.
The remarkable moves in the stock market on the back of this forum have produced two camps. There are those who say these retail traders are colluding to manipulate the market and force these stocks to territory in which they have no business being (see also: Tesla). Subscribers of this view seem to be mostly Wall Street natives and the surrounding media outlets.
Then there are those who say the markets were already manipulated, in particular by the hedge funds who had put on artificially large short positions to begin with and had not appropriately managed their risk. Those in this camp tend to ask: Why shouldn’t retail traders be allowed to do this?
Why shouldn’t they indeed? After all, if it was another hedge fund executing this trade and short squeezing the market, it would just be another day on Wall Street. That the adversary here is a sort of decentralized swarm of retail traders is what makes the phenomenon both remarkable and controversial. And it highlights a double standard.
Markets are not actually free.
The trading floor, as I once knew it, was not all that different from the WallStreetBets Discord chat. It was a place of stress, euphoria, arguments, cooperation, laughter, name-calling, insights, inappropriate remarks and banter. It also had the same clubby, in-group feel that online communities often develop. Those who worked there had nicknames, jargon and their own way of talking about things.
Think of the portrayal of trading desks in every bit of media you have ever consumed. The people pounding desks and putting their fists through screens; the bosses swinging baseball bats around; the rolled up sleeves and dilated pupils; the obscenities. When Yale-educated men in button-downs engage in these behaviors, they become the Masters of the Universe. Yet, when anonymous online avatars and energetic YouTube personalities do so they are cast as immature, basement-dwelling kids.
The double standard at play here extends beyond the conduct and deportment of these two groups. It also extends to their methods of engagement in the markets. When hedge fund managers get together and share insights and ideas, it is all in the name of moving towards a more efficient free market. Yet, when the online mob of retail traders comes to consensus about which stock is worth buying, they are considered by some to be artificially pumping the name and manipulating the market.
So, are they manipulating the market? Again, the situations of this past week highlight just how strange this question has become. In some ways, one cannot participate in the market without manipulating it. The very act of buying and selling is, in some way, manipulation. There are of course more extreme forms of it: painting the tape, spoofing, pumping and dumping.
Generally, but not always, these involve some level of privileged access – either to the market at hand or to the infrastructure of the market. This is part of what makes the accusations of retail manipulating the market comical. These traders came to the fight armed only with the Reddit forum and their Robinhood accounts.
This is the problem with thinking that whatever the market is doing must be right. Market participants are not equally equipped as they walk into the market to do battle. Markets are not actually free, meaning they are distorted away from theoretically optimal pricing. The realities that certain players have access to more capital, more leverage and more financial instruments to express their views render the markets manipulated by default.
It is worth noting that the GameStop phenomenon would not have been successful for these retail traders without the power of options and leverage. It is often said that Robinhood is democratizing trading. It is also democratizing access to these powerful market tools, leveling the playing field in a way that hadn’t been done before.
This brings us to another double standard. Much has been made of the dangers Robinhood poses for its retail customers. People should not be allowed to trade with leverage, the wisdom goes. They do not know what they are doing and they will get hurt. In this situation, however, it appears that it was a certain institutional hedge fund that did not know what it was doing and got hurt. Of course, for institutions the world provides crash pads and government-funded bailouts. For retail, this is not a possibility. And so the only way forward we offer is the old wisdom: Don’t invest what you can’t afford to lose. Just put your money in an index fund. Stay out of the markets if you do not understand them.
But the rules are changing. Who doesn’t understand the markets now?
@Lynxabi Yup, 100%, she was all about capitalism, people that hate her would be defending the candle-makers and making sure electricity does not destroy candle jobs.
@johnnymidlife You’re LIAR! I never said that. I’m pro-trump because he is the best president America had in my lifetime. He represents capitalism in a fight against Communism.
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But his re-election will lead to civil unrest, because most people want socialism. $BTC will rise regardless.
