You have probably heard of the petrodollar. You may not know the ins and outs, but you have heard the term in history class or on some podcast. In a very simple and reductive way, it is an abstract noun meant to show the political and military denomination of the United States’ dollar as the sole purchasing currency of oil. By creating the exclusive medium of exchange to be their dollar, be it in treasuries, bonds or cash, the United States could “quantitatively ease” their expanding monetary supply into the ever-demanded energy commodity that is oil.
The idea of tying your monetary system to an energy system might seem a bit odd at first, but consider the actual exchange of capital to be one of time spent earning the pay (working debt for credit capital) for a direct-product-of or service-based expression of the seller’s time. It might seem trite, but time is money; perhaps the truest commodity of the free market. So, by tying your hard-earned greenbacks to an energy-derived system, one can help preserve the scarcity of time spent earning.
This is the concept behind the numerous bimetallic standards the United States has applied before, during and after the revolution of 1776. One central bank and 195 years later, Richard Nixon closed the gold window, severing the stable tie of the dollar to the price of gold, and escorted us into the wide and open skies of fiat currency. What felt like high flying through the following decades was actually falling deeper and deeper into the cavernous hole of an ever-expanding debt balloon. Monetary growth expanded from $636 billion in January 1971 to an absurd $7.4 trillion by the time our fiat experiment caught up to us in the winter of 2007. The pressures of the cascading defaults of a Frankenstein financial creation hit in 2008; a monstrous body of illicit subprime mortgage speculation with the head of a eurodollar system liquidity squeeze.
By the time the news broke of a single hedge fund in the EU defaulting, the fears of insolvency among the system ran as far as New York City. Thirteen years ago this month, a bank run at the fractionally reserved Lehman Brothers drained the 161-year-old institution in a single afternoon. Why would issues with the credit of a single firm cause a global recession? Why would a bad trade for a hedge fund have this much effect on the United States dollar system, never mind the rest of the world’s currencies? The answers are concurrently abstract in exact psychological cause, for, after all, money is just a communications tool, but shockingly simple in an economical sense. Every market, of every kind, can be reduced to simple supply and demand. Every market, at the fundamental core, consists of buyers and sellers. So how did this assumed localized liquidity crisis occurring from a hedge fund default suddenly become a worldwide problem?
Not only did they not have the money to pay the debt in liquid reserves in the bank when the chickens came to roost, but they had already previously sold packaged shares of their debt around the global financial market. Larger hedge funds happily bought these compartmentalized debts in order to allow portions of their wealth to earn interest in the form of another firm’s debt. It was a nice gambit for a while; the smaller, less liquid companies got access to much needed credit, and the larger, more established companies got to earn slim but compounding percentages on assumed future profits. Everyone’s a winner, baby. But when one of those small debtors goes under, like in the case of the narrative of a local default due to some poor and over-leveraged mortgage plays, the larger firms are caught holding the realized loss of their now defaulted debt purchases; overnight that cheap and easy debt became very expensive.
But these days of wine-and-roses ponzi of repackaged, fractionalized debt-for-credit-now was not just enjoyed by a small chain of firms but rather the near entire financial system. The once healthy and strong tree was now a rotten log, eaten away from the inside by vicious, parasitic debtors and gluttonous, grubby creditors. A system-wide dollar liquidity crunch led to defaults and bank runs while, simultaneously, defaults and bank runs led to a system-wide dollar liquidity crunch. A financial crisis perfectly placed right between a Red and Blue president should sound awfully familiar.
But in 2007, there was Ben Bernanke, nominated by George W. Bush and later renominated by Barack Obama, to bail out the banking system that just got caught with their pants down. After gambling with homeowner’s debt via fractional reserve margin plays, the American banking system turned to the lender of last resort, the Federal Reserve, to generate liquidity by printing dollars. The future money printing savant Steven Mnuchin, then of OneWest Bank, profiteered on the bailouts, collecting massive service fees and executive bonuses for the very people and corporations that caused (see: benefited from) the recession in the first place. As the working class licked their wounds and prepared for winter, the Cantillionaires feasted on an eroded housing market and cheap index funds.
We have seen practically nothing but unmitigated growth in markets since these purple bailouts, that really only stood to further drive wealth inequality in the coming decade, and further yet exacerbated by the pandemic. The once unifying financial protests slowly faded into a divided, bipartisan culture clash, with the liberals blaming the Bush administration and the conservatives blaming Obama’s. In a sign of mutual-assured profits, when given the opportunity to prosecute Mnuchin of aforementioned fraud, then acting DA of California and now Vice President Kamala Harris declined to press any charges whatsoever, and, in fact, he later became the Secretary Treasurer only a decade later under President Trump.
So we can see how the violent monetary base expansion of the United States dollar could inflate away the purchasing power of an individual dollar, hurting savers and those with dollar-denominated positions, but why did this not hurt the United States’ purchasing power on a net basis? Why didn’t the massive inflation of dollars, from well under $1 trillion in 1971 to $10 trillion in 2012, bring the economy to its knees and relinquish economic reserve hegemony to China or Japan, our biggest debtors? By the time millions of Americans found themselves without homes and the Occupy Wall Street movement fizzled out, the Federal Reserve was back to business as usual, raising interest rates and resuming sales of bonds to foreign entities, and eventually, to itself. How were we able to fight off the mechanics of an unhinged money supply decreasing its demand?
The reality is, the United States never truly left an energy standard, we just simply switched from a gold-backed dollar system, to an oil-based dollar system. With the decree of 1971, the gold dollar was destroyed, and in its place, the petrodollar was born. American Imperialism has worn many clothes, red and blue cloth alike, but it has always been for one purpose: to make more money. The activity in the Middle East, starting with the marines landing in Beirut in 1958, mutated into a proxy war in Afghanistan between the USSR and the U.S. during the Cold War, and finally grew into a full-scale occupation in the summer of 1990 with Bush Senior’s directed invasion of Kuwait.
By occupying the oil-rich nations of the region, the United States enforced sole denomination of the market share of all petrol sales to foreign entities in dollars. This allowed the Fed to expand our monetary supply, slowly but surely over 50 years, with no apparent loss of demand. Oil-dependent countries across Eurasia were forced to buy dollars first, before then purchasing the precious petrol needed to power their industrial expansion. By 1990, the U.S. dollar system had expanded to $3 trillion dollars. Over the next 30 years, the United States had expanded itself with maneuvers in Iraq, Syria, Lebanon, Yemen, Turkey, Jordan, Saudi Arabia and only now are we removing the last remaining military presence in Afghanistan; by the fall of 2021, the U.S. dollar system stood at $20 trillion.
So, why are we moving military presence out of the region now? Seems like an inappropriate lever to give up in a time when inflation has been acknowledged by retail and a pandemic disrupts supply chains and labor forces across the globe. Why would we want to jeopardize our world currency reserve status by removing our ability to prop up the dollar’s demand, as global interest rates sit at zero, and some, in fact, below it? A ponzi cannot simply be tapered, and we now find ourselves mere weeks away from smacking into our debt ceiling and risking default.
Historically, the United States has raised the debt ceiling countless times in recent memory, across all expressions of political spectrum in the three branches of government, and such are trained to expect the same. We have always had a place to put that new found supply of debt expansion, into the forced demands of a petrol-based dollar system. What makes this threat of default perhaps different from the 2008 crisis? It is nearly the same set up, with a diversified, debt-riddled real estate market on the brink of defaulting, with China’s Evergreen playing the role of the Lehman Brothers, causing a short-term deflationary pressure on the global dollar system. We know more printing is going to come, to prevent default of China’s real estate market, as well as prevent the U.S. from defaulting on its loans.
But it isn’t quite the same for a mathematically succinct reason; the compounding service on our near $29 trillion dollars of debt is now beyond the growth of the GDP of the country. We cannot simply raise interest rates due to this debt service, and yet with the acknowledgment of inflation running far beyond the assumed 2% per year, the once formidable long-term treasury bond yields have made the $120 trillion dollar-denominated bond market mathematically worthless. If a bank bought a large amount of 10-year bonds expecting a yield of 2% over a decade, their money is now stuck no longer generating any profits. The not-yet matured bonds went from guaranteed profits to not even keeping up with the inflationary action of the dollar in just the first year.
The last time we saw the markets on the ropes was March 2020; oil futures went negative, bitcoin halved in value, and precious metals and stock indexes across the economy hemorrhaged value simultaneously. If you were lucky enough to have supplied yourself with the knowledge, it was a once-in-a-generational buying opportunity for commodities. A mere two months later, Bitcoin nodes across the globe enforced the third of 33 supply issuance halvenings and decreased the block reward from 12.5 BTC to 6.25 BTC per mined block. For the first time ever, the relative bitcoin supply issuance was below 2%, and thus below the average inflation of both gold coming out of the ground and the average inflation of the United States dollar. By that same time next year, bitcoin had run from just above $3,200 to nearly $65,000. There were very few aware of it at the time, but on that dark Thursday back in March, a new financial instrument was born: the bitcoin-dollar.
Satoshi Nakamoto’s Bitcoin was directly inspired by the events of 2008, immortalizing The Times’ headline from January 9, 2009, in its inaugural genesis block. Today, we find ourselves again on the brink of another bail out. A signaling of the Fed on their dot chart of tapering off bond purchases causes market retraction, and an explanation the next day by a Fed chair causes dovish reclaims of yesterday’s all-time highs. If we raise interest rates, we can no longer afford our debt service, and if we don’t raise interest rates, we allow further debt expansion, monetary debasement and loss of purchasing power of the net dollar system. How can we continue to keep up demand for the dollar while still pumping the money supply to pay off our compounding debts? In retrospect, it was inevitable that the first country to adopt bitcoin would be dollarized. El Salvador, the first nation state to adopt bitcoin as legal tender, is one of 66 dollarized countries in the world. Not only does nearly 70% of the population remain unbanked but almost a quarter of their GDP is created via USD-denominated remittance payments. Native to the execution of their Chivo wallet, a Lightning-enabled app based on Jack Maller’s Strike, is the use of a stablecoin pegged to the dollar. In fact, in a few regions, Strike directly uses the oft-misunderstood Tether, or USDT; the largest stable coin by market cap at nearly $70 billion.
Why does this matter? Aren’t customers simply using the dollar stable coin for a moment before transferring and storing their value onto the Bitcoin network? By creating an infrastructural on-ramp to Satoshi’s protocol that is denominated in dollars, in effect, we have recreated the same, ever-present demand for an inflating supply of dollars demonstrated in the petroldollar system. This does not mean you can not use euros or pounds to purchase bitcoin, just like there was never a literal monopoly on the sale of oil in dollars, but the volume on BTC trading pairs is arguably inconsequential outside of dollar-denominated markets; BTC/USD pairs make up the vast majority of volume on the global market. By expanding the Tether market cap to $68.7 billion during the first dozen-or-so years of Bitcoin’s life, when 83% of total supply was issued, the U.S. market made sure the value being imbued into the now-disinflationary protocol would forever be symbiotically related to the dollar system.
Tether isn’t simply “tethering” the dollar to bitcoin, but permanently linking the new global, permissionless energy market to the United States’ monetary policy. We have recreated the petroldollar mechanisms that allow a retention of net purchasing power for the U.S. economy despite monetary base expansion. If the peg of a dollar-denominated stablecoin falls below one-to-one, large arbitrage opportunities are created for investors, bankers and nation states to acquire dollar-strength purchasing power for 99 cents on the dollar. This occurs when expanding stablecoin supply leads to less demand, and those trying to purchase dollar-denominated commodities on bitcoin/USD pairs are forced to sell at a slight perceived loss. So, like any market, when supply increases causes demand to decrease, the selling price moves down; the selling price moving down briefly below a dollar causes demand to increase and suddenly we are repegged at 1:1.
The reason this works uniquely with bitcoin versus oil or gold is the verifiable, auditable and scarce monetary policy of the Nakamoto Consensus; there will never be more than 21 million bitcoin. By combining a decentralized timestamp server via proof-of-work to solve the digital double-spend problem, with a hard-capped token distribution that is innately tied to its security and decentralized governance, bitcoin is the only commodity to break the pressures of increasing demand on inflating supply. If gold doubles in price, gold miners can send double the miners down the shaft and inflate the supply twice as fast, thus decreasing demand and price. But no matter how many people are mining bitcoin, no matter how high the hash rate increases this month, the supply issuance remains at 6.25 bitcoin per block. Bitcoin is the only decentralized financial model in existence, and most likely the idea of a “decentralized stable coin” is pure logical fallacy.
How can you distribute, secure and order transactions in a decentralized manner when the monetary policy itself is innately tied to the whims and dot plots of a seven-person centralized Federal Reserve? Tether and the grander stablecoin system is a money market for the digital financial market place at large. By creating a robust, heavily margined ecosystem perpetuated and overwhelmingly supported specifically with inflows from dollar-denominated tokens, Tether and the like have pegged the short- and medium-term success of the bitcoin market to the dollar; when bitcoin retracts, arbitrage opportunities now exist for the dollar system to inflate further into the hard-capped, ever-demanded monetary system of Bitcoin. This pendulum-like market mechanism is the key component of the most important technological advancement in the finance world since the energy-based bimetallic and oil standards of yore. The world economy now finds itself irreversibly changed by the dawn of the bitcoin-dollar era.
Perhaps we should be less surprised by this realization than we are; the clues for an encouraged and implicit governmental policy approach to the dollarization of bitcoin are numerous. For starters, SHA-256, one of the secure hashing algorithms used in the Bitcoin network, was invented by the National Security Agency. But from strictly a financial and regulatory standpoint, the United States has significantly much more to lose than most with a net loss of purchasing power of the reserve dollar system.
Nearly four times as much profit was generated by Americans off bitcoin investments in 2020, at around $4.1 billion, than the second closest nation (China at $1.1 billion). Would the U.S. Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) let American investors send a lofty percentage of our retail GDP value to an open-source network without a plan to conserve our purchasing economy? An ETF has yet to be approved by either of these regulating bodies, and yet they allow companies like MicroStrategy to take advantage of zero-interest rates and amass cheap debt to make, by all definitions and metrics, a speculative attack on the U.S. dollar system. The six figures of bitcoin purchased on their balance sheet are now worth billions of dollars, surely raising the attention of their next-door neighbors in Langley Park. If the U.S. was afraid of losing economic hegemonic status via bitcoin speculation, they would simply not allow exchanges and companies to do such dealings within their jurisdictions.
In regards to new financial regulations, legislation like Basel 3 requires companies to have considerable holdings of on-sheet liquidity to offset speculations into commodities and assets. On New Year’s Day, any bank wanting to hold a bitcoin or gold position would also be required to hold an equal-part dollar to dollar-denominated value of their investments. This forces a net demand for dollars in the dollar system in spite of a loss of individual purchasing power due to inflation. There is certainly a future regulatory reckoning coming in the unregistered security sales of centralized protocols with known human leadership, but even Gary Gensler, the now acting chair of the SEC, has determined Bitcoin and Nakamoto’s innovation as “something real.”
You can almost reductively view the consumption-based, ever-expanding debt bubble of fiat currency as a large balloon, and the conservation-encouraging, hard-capped and distributed protocol of Bitcoin as a vacuum. By allowing somewhere for the United States monetary supply to inflate into, we can pay off our immense debts without losing any demand or net-purchasing power via the congruent appreciation of bitcoin to the dollar. Pegging this new energy remittance market to the dollar during the increasingly important first decade of tokenized supply issuance has now forever linked the fates of the purchasing power of the dollar to the store of value properties of bitcoin. The United States has proven time and time again that they will do whatever is necessary to protect the purchasing power of the dollar system. The bitcoin-dollar is simply the next evolution of the energy-capital system needed for a functioning global economy. Perhaps the time has come for the Oracle of Omaha to take his own advice and never bet against America; the petrodollar died in March 2020, but like a phoenix rising from the oily ashes, so, too, was born the bitcoin-dollar.
This is a guest post by Mark Goodwin. Opinions expressed are entirely their own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.
Historically, hyperinflation is a positive feedback loop of free money, illusionary wealth and greed.
Almost two thousand years before the early 1920s Weimar Germany hyperinflation, there was the great currency debasement of the Roman Empire.
At the turn of the second century, the Roman Empire controlled all of Western Europe, parts of North Africa and the Middle East. Some estimate up to 65-100 million people lived under Roman rule, with 55–65 million as the most accepted range. — approximately 20% of the world population.
Yet, 150 years later the empire was near collapse. There are many factors which caused the “Crisis of the Third Century” (A.D. 235–284) — notably, factors such as political disorders, corruption, slowing expansion, wars etc. The biggest factor in my opinion was the debasement of the Roman currency. The debasement of the Roman currency ultimately led to over-taxation and inflation, which in turn caused a financial crisis.
The gradual debasement of the Roman currency/coin can be tracked through the metal composition of the denarius. The silver denarius was minted for common use during the first two centuries of the Roman Empire. A four-gram coin was composed of 95% silver at the approximate time of A.D. 60. By A.D. 110, a 40-gram coin was made of only 85% silver.
By A.D. 170 the denarius was made from 75% silver, and only 60% silver by A.D. 211. By A.D. 270 this was finally reduced to merely 5% silver. Soon thereafter, Rome abandoned using silver in their coins altogether, switching to bronze to mint their coins. Inflation was severe as the value of the currency declined.
By A.D. 290 new coins such as the solidus were introduced in an attempt to halt inflation. The introduction of a “new” currency to halt inflation seems to be a staple of any hyperinflationary event. The same thing happened in Weimar Germany in the 1920s when the government implemented the rentenmark (issued Nov 15, 1923) to stop hyperinflation of the papiermark. At the end of 1922 a loaf of bread cost around 160 marks, yet by late 1923 that same loaf cost 200,000,000,000 marks. Using these historical markers, I find it very interesting when I come across a headline that states that central banks are desperately trying to “fast track” central bank digital currencies (CBDC’s). Like the rentenmark and the solidus before it, a “new” fiat currency is just more of the same problem, but with a shiny new branding and nametag.
The solidus failed to halt runaway inflation in Rome, leading to the “Edict on Maximum Prices”. The edict was designed to “cap” the prices of over 1,000 goods and services. The edict was also unsuccessful. Similarly in Weimar Germany, rent controls were put in place in an attempt to stem the rising inflation trend. Towards the end of the third century, prices of goods in Rome were now 70 TIMES what they were two centuries prior and most of that price increase would have occurred in the last decade (A.D. 290).
What began as steady devaluation soon became a rapid destruction of the currency in Rome. You see, the debasement starts slowly at first (it always does). It’s easy to debase in the beginning. Shave a little silver here, add a few more coins there, what’s the big deal!? Besides, we are creating new money (early-day money printers) for the economy and that’s great! Or is it? The problem is currency debasement is a lot like heroin (I wouldn’t know personally, but stay with me). The first time you use it is the most potent. Afterwards, you are constantly trying to take more and more to get the same “high” — economic stimulus via printing new money. In the end, you overdose by taking too much. The same holds true for currency debasement; in the end your currency collapses.
Where this history lesson becomes eye opening to me is the striking similarities between the Roman silver content chart (chart intentionally inverted to show the amount of the coin which is NOTsilver) and the balance sheet of any central bank in the world these days. For this example, see the U,S. Federal Reserve balance sheet below. The similarities of these charts should be a massive fire alarm in your head screaming “WARNING!” Despite these charts being from very different time periods and time lengths it is the rate of decay (shoutout to Greg Foss for that term) that is most astounding. The rate of decay — or relative purchasing power — for both charts follows a very similar path.
You see, the problem with currency debasement is that it is a hard habit to kick. Worse, most don’t even realize that it’s bad. This held true in Rome, held true in Weimar, Germany and holds true today. History is rhyming. U.S. politicians in power do not see balance sheet expansion as an issue that needs solving. Worse, they do not see it as a cause of inflation, or that high inflation is bad. Currency debasement is a one-way street. The boulder only rolls downhill. Greg Foss said it best “I am 100% certain that fiats will continue to debase…. on an accelerated basis.”
They simply cannot turn off the printers. If they attempt to slow down inflation (typically by raising interest rates and turning off the money printers), within weeks if not days, you would see immediate bankruptcies, unemployment, strikes, hunger, violence, and possibly even revolution in an extreme case. The government and by extension the banks are backed into a corner. This is a carbon copy of the same issues that Weimar faced and Rome as well. No country/government willingly chooses hyperinflation. Frankly, historically it has been the lesser of two evils. That does not make it any better (frankly, one could argue that it is way worse), but it occurs less directly than a massive deflationary event.
In reality, expanding the balance sheet at an exponential rate makes the problem worse and worse until it finally cannot be ignored any more. They will keep printing until the effects of inflation are WORSE than the effects of not printing. Full stop.
You need to protect yourself against inflation by purchasing hard assets. Buy bitcoin, gold, silver, and/or real estate. Things that are hard, scarce and difficult to reproduce. Agricultural farmland also historically has a high correlation to inflation. Even if you are a gold bug or a silver bug, your allocation to bitcoin should not be 0%. Nobody can predict the future with 100% certainty. As a result, your bitcoin allocation should not be zero either in the event that you are wrong. Finally, get educated on what’s going on; there are many people online who are willing to help and share information freely.
This is a guest post by Drew MacMartin. Opinions expressed are entirely their own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.
The idea of a layer comes from two worlds, each of which uses a layered approach in a distinct manner: the world of money, and the world of networks. In this article we will briefly explore both worlds. After the concept of layers has been established, we will relate the layered framework to Bitcoin, which is a unique and new hybrid of both money and technology. We will introduce the nuance of layers, and propose that distinction in language is used in the absence of redefining historical context or using an entirely different nomenclature.
Layers A La Moneys, Historically
Monetary layers have emerged many times throughout the course of history for a variety of reasons. Most notably, layers occur as a mechanism to ease the transfer of money from one party to another.
Let us consider the U.S. dollar during the pre-1971 era. Both gold and silver were legal tender and could be used to make transactions. These precious metals are not easily divisible and have other physical characteristics that make them undesirable to use in day-to-day transactions, such as ease of transport. For his reason, a second monetary layer emerged: one in which the bank held gold deposits on your behalf, and provided you with an IOU note representing that deposit. This note would be redeemable for the gold, and the bearer of this note has claim to the gold deposit.
Instead of transacting with gold, individuals would now transact with the notes representing the gold. As we would see later in history, this system was rife with corruption. This is the story of the U.S. dollar and the ultimate failure of the gold standard. For an in-depth dive into the world of monetary layers, I recommend reading Nik Bhatia’s “Layered Money”.
Layers A La Networks, Historically
The digital world brought with it the emergence of digital networks — most notably, the internet. The internet as we know it and use it today is a layered architecture referred to as the Internet Protocol Suite, or TCP/IP for short.
A layered protocol approach allows us to reach consensus and break very complex ideas down into separate components. It also provided interoperability such that end users can plug in with their own products or software.
Layers A La Bitcoin
Conversations about applying the layered framework to Bitcoin often end with little to no consensus, as Bitcoin distorts and blurs traditional intuitions. This distortion stems from Bitcoin being both a money and a network, each of which, historically, has a layered framework that is distinct from the other. Most disagreements about bitcoin layers are due to the proponents talking right past each other.
Let’s start with some common ground, where most folks would agree: Bitcoin Layer 1. The Bitcoin protocol is enforced by the operation of full nodes. These nodes store the entire Bitcoin blockchain and validate the legitimacy of transactions that miners include in blocks. Generally, the first layer of Bitcoin is the set of interactions that falls within the full node enforced protocol: cryptographic ownership of a UTXO, a transaction from address A to address B, the block height of the current block, etc. Simple, right? That’s because the first layer of Bitcoin fits cleanly within both the Layer 1 monetary application and the Layer 1 technological application frameworks. They reconcile with each other entirely.
The Bitcoin Protocol:
Monetary Layer 1: Check
Network Layer 1: Check
“The full node enforced protocol is the Layer 1 of Bitcoin”: Check
As we continue on to the second layer of Bitcoin, it is important to understand why we need a layered approach in the first place. Everything in life has trade-offs, including Bitcoin. The Bitcoin protocol is optimized for both dentralization and security on its first layer, which is achieved through limited block space and ten minute block intervals. These critical parameters severely throttle the amount of transactions that the Bitcoin blockchain can process, which is in the ballpark of five to seven transactions per second. However, these parameters allow for more individuals to run a Bitcoin full node (decentralization) as well as enabling a competitive fee market for transaction confirmation (security). For these reasons, scaling Bitcoin to billions of users on the base layer is not possible. The Bitcoin blockchain will be the global settlement layer used by individuals, banks, and corporations willing to wait a few minutes and pay an on-chain fee for final settlement. The Layer 1 blockchain will be used for finality, while other layers will be used for other applications, such as day to day transactions (a coffee being the classic example).
Having said that, it is useful to explicitly define what solution a layer is providing to the Bitcoin network. Often, layers are trying to solve the limited transaction capacity of BTC on the main blockchain, as described above. This is not to say that some layers may not focus on other problems (such as privacy), but for simplicity and the scope of this writing, we will examine layers with transaction scalability applications.
In theory, the approach of solving transaction scalability is quite simple: many transactions shall be embedded within one on-chain (Layer 1) transaction. We lock some BTC away, pass it around to each other indefinitely, then throw it back to the mainchain for settlement. At the heart of it, this is a Layer 2 Bitcoin application. It is now an appropriate time to introduce the concept of “on-chain” and “off-chain” transactions, which some would argue is more clear than using the jargon of layers and all of the semantic baggage that comes with it. Put simply, an on-chain transaction is any transaction that occurs on the Bitcoin blockchain (I send some BTC to a BTC address that you provide me), while an off-chain transaction is any transaction that occurs off the Bitcoin blockchain (I send “IOU” BTC balance from my Cash App account to your Cash App account). By definition, all Layer 2 solutions on Bitcoin make use of off-chain transactions as they are not in the scope of the full node enforced protocol.
A Monetary Layer Relationship To Bitcoin:
By following the historical concept of a monetary layer, we can define a Bitcoin monetary Layer 2 as any form of off-chain interaction that transfers a balance of BTC from one entity to another. The transfer of a BTC balance can happen in the form of an IOU, or in the form of actual ownership. This kind of monetary Layer 2 interaction can happen in many forms: through a third party, through the transfer of a private key, and even peer-to-peer via a network Layer 2 (discussed later). The recipient of this interaction has a claim to that amount of BTC on-chain, but does not receive exclusive ownership to the actual on-chain BTC until a separate on-chain transaction occurs.
It is important to note that not all monetary layers are created equal. They come on a spectrum of trustlessness, and many are entirely antithetical to the ethos of Bitcoin. Although we may not like it, the precedent of monetary layers has been established by history and we would need to redefine historical and semantic context to avoid Bitcoin’s association with monetary layers. Alternatively, we could avoid the concept of monetary layers and use different nomenclature entirely.
A Network Layer Relationship To Bitcoin:
By following the historical concept of a network layer, we can define a Bitcoin network Layer 2 as an interoperable protocol that is cryptographically pegged to the mainchain in a trustless manner. Being that the Bitcoin protocol forms a network, it is understandable that a network layer approach would be used to enable a multitude of operations. A transaction scalability capability would be a prime application for a network Layer 2 on Bitcoin. This would enhance features of Bitcoin without compromising any optimizations of the first layer. Any form of transaction scalability network layer would also be considered a monetary layer by its very nature of facilitating transactions off-chain.
What we actually consider a network layer on Bitcoin is going to be a bit controversial, but it is worth exploring and defining. For starters, a network layer must be a protocol that is interoperable with the Layer 1 Bitcoin protocol. Secondly, a network layer on Bitcoin respects all of the sovereign aspects of Bitcoin’s Layer 1 protocol. This includes its peer-to-peer nature, and its disintermediated verifiability. A network layer must not make use of IOUs in any form, as requesting to redeem BTC would invalidate the non-custodial nature of Bitcoin. For now, these qualifications are enough.
There is a clear and important distinction to make when referring to a layer on Bitcoin. I propose that something be referred to simply as “a layer” only if the criteria for a network layer is met. Otherwise, it is just a monetary layer and should be referred to as its application name (ie. Cash App), or explicitly stated to be a monetary layer in the historical context of the words. The reason for this is that the historical context of monetary layers are in contradiction with the Bitcoin ethos, and conflating the two sets a bad precedence of language.
I do not believe we should redefine language and historical context to fit our agenda. For that reason, we must be precise in our words or create a new nomenclature entirely. Although it may be technically correct to refer to a monetary layer as a layer of Bitcoin, I believe it to be a dangerous precedent. We have seen the gold standard fail through a monetary layered framework, and applying this same framework to Bitcoin would undermine the sovereignty that Bitcoin enables.
Let’s be mindful of both the monetary and network layered aspects and walk through some actual examples:
A Bitcoin Exchange:
A Bitcoin Exchange is a custodial service which allows users to trade fiat for BTC. These exchanges generally allow users to transfer “IOU” BTC balances to other users. Specifically, this includes Cash App, Coinbase, Venmo, and many others.
The Bitcoin Exchanges:
Monetary Layer 2: Check
Network Layer 2: NO
“Exchanges are a Layer 2 of Bitcoin”: NO
The Liquid Network:
Liquid is a federated sidechain that operates independently but pegged to Bitcoin. The Liquid Network allows the general public to transfer BTC to L-BTC (the Liquid Network native asset), but requires functionary members to approve transfers of L-BTC back to BTC. Once a user has L-BTC, they can transfer it to other individuals using the Liquid Network. From the perspective of Bitcoin, this is an off-chain transaction, with L-BTC acting as “IOU” BTC.
The Liquid Network:
Monetary Layer 2: Check
Network Layer 2: NO
“The Liquid Network is a Layer 2 of Bitcoin”: NO
The Lightning Network:
The Lightning Network is the only layered application mentioned thus far that meets the criteria of being a Bitcoin network layer. Lightning allows users to maintain cryptographic ownership of the BTC they are interacting with, and allows users to redeem an on-chain UTXO without the approval of any third parties. The Lightning Network makes use of a multi-signature and channel based operation schema, which is largely beyond the scope of this article. For now, it is just important to know that the Lightning Network is trustless and peer-to-peer.
The Lightning Network:
Monetary Layer 2: Check
Network Layer 2: Check
“The Lightning Network is a Layer 2 of Bitcoin”: Check
There is a historical precedent for layers in both money and networks. Bitcoin is unique in that it is both a money and a network, which means it has distinct money and network layers that are often at odds with each other. I propose that something be referred to as a “layer of Bitcoin” only if it meets the criteria for a network layer. If only the money layer framework criteria is met, the application in question should be referred to by name, or explicitly noted to only be a monetary layer in the historical context of the words.
I want to note that I am not trying to mandate speech or tell you what you cannot say. I just believe this nuance to be important, as we are trying to escape the failures of all money that came before Bitcoin. If you found what I’ve written to be convincing, then feel free to join me!
If you’ve made it this far I hope that my perspective was clear and coherent. I’m sure this entire article could have been summarized in a few tweets, but I wanted to articulate all of the nuance that I believe this topic deserves. Do you agree with the premise? Disagree with the premise? Let me know what the f***is a layer on twitter @thefuckisalommy. Cheers.
“Give me six hours to chop down a tree and I will spend the first four sharpening the axe.” -Abraham Lincoln
To understand the implications of a paradigm changing technology, one must intimately understand the problem that is being addressed. If we do not understand the problem at a granular level, how can we ever determine what may be a suitable solution? Bitcoin has been obtuse to many, the reason being that most simply do not understand the problem of money; if you are one of these people, don’t be hard on yourself — very few do understand. With this writing, the aim is to help the novice learner become familiar with our current problem of money. Once the problem is understood, the solution becomes obvious. When speaking to radical disruption, humans have a hard time adapting to a new reality. This is not only due to fear of change, but more so, we are psychologically conditioned to our environment — we cannot see that something is broken when it is all we have ever known.
“If I had asked people what they wanted, they would have said faster horses.” — Henry Ford
Everyone that is now a Bitcoin evangelist was once a Bitcoin skeptic — this rule applies with very few exceptions. Bitcoin is an excruciatingly complex system that requires a working knowledge of economics, computer science, open-source software, game theory, the global political landscape and investment strategy. Bitcoin is an open-source, globally distributed protocol for transferring and storing value; but, just as important, it has a vast technology stack being built out on top of the base protocol — drastically expanding Bitcoin use cases. Bitcoin can mean a wide variety of things to different people with different motivations and has a near infinite number of potential use cases. From this worldview, Bitcoin dominates without rival on three core applications:
Finite and programmatic money supply issuance with no risk of debasement (inflation) — in essence, the wealth you own will not degrade over time.
Nearly unconfiscatable wealth. Globally, 4.2 billion people live under oppressive regimes and dictatorships that confiscate wealth from citizens either through force or capital controls — these citizens do not have the option to leave as their bank accounts will be frozen.
Uncensorable speech in the form of money. Around the world, authoritarians use banking and money as a primary tool to silence their opposition through freezing accounts and prohibiting funding. This inability to fund an oppositional voice can lead to drastic imbalances of power, in which the prevailing regimes can commit unilateral atrocities against their citizenry.
In my view, these three applications are critical to Bitcoin’s success, and the expanding universe of subsequent applications are icing on the proverbial cake. Many newcomers to Bitcoin, believe these three use cases of Bitcoin to be unimportant or a “solution in search of a problem.” Which is understandable as it is common to look at things through the lens of Western democracy. Economics, central banking and money are very boring concepts to most. People are busy raising families, advancing careers and trying to make ends meet — we trust that “experts” have these things figured out. We don’t have time in our busy lives to dig into quantitative easing, interest rate policy, RePo markets, currency game theory among competing nations, the rationale for negative yielding bonds, why economic inequality has become so staggering, and how everything has become “so damn expensive?” Bitcoin can and is a solution to many of these topics; however, we will never understand why Bitcoin until we understand the underlying problem it solves. As Abraham Lincoln said, “If you give me six hours to chop down a tree, I will spend the first four sharpening the axe.” Just as sharpening the axe is key to chopping down the tree, understanding the problem is key to Bitcoin enlightenment. Let’s work to understand the problem, time to sharpen the axe.
What Is Money
It could be argued that money is the most important technology of any society. It quite literally represents half of every transaction that occurs within a society. Despite our daily use of money and how it controls our lives in many ways, we collectively have a very poor understanding of what gives money value. In short, money should simply be an abstraction of value that frees us from the inconvenience of barter — or easier said, a ledger of who owns what.
The below list are the defining characteristics that make up for a stable and dependable monetary good:
I will spare the reader the laborious task of going through each of these characteristics in great detail; but I will instead focus on the key deficits in our current monetary system and how the Bitcoin protocol fixes them. We must first have an elementary understanding of monetary history and how we got to the precarious precipice we find ourselves in today.
A common resounding artifact of any culture is the type of money that each culture utilized. Money, in many cultures, started out as beads, feathers and other rare artifacts. These systems of money didn’t work well primarily due to the fact the monetary good was not fungible. To illustrate this lack of fungibility would be the example of seashells used in many cultures. No seashell is exactly the same as any other seashell in terms of size, shape, aesthetic appeal and condition. With these disparities, it led to a lack of fungibility and the buyer and seller had to resort to negotiation of the value of the particular seashell in question — making pricing difficult. Another key component, and arguably the most important of all currencies, is scarcity. We cannot use rocks as currency evidenced by supply being near infinite; no rational economic person will trade finite goods and services for an infinite amount of money. As Andreas Antonopoulous points out, “One can look at archaeological dig sites, in which mountain civilizations used seashells as currency because it comes from the coast, and coastal communities utilized quartz as currency because it comes from the mountains — as long as this resource is not naturally occurring where you live, it has the potential to be a good money.”
In 600 BC, a major breakthrough was reached to solve this issue of fungibility, scarcity and, in many instances, portability. Portability is the ease at which a monetary good is transacted throughout space. The minting of rare metal coins became the solution to a lot of challenges plaguing early monetary systems.
Gold and silver have served as sound money for millennia and their track record is undeniable. If you had one Roman denarius coin, it was exactly equal in value to any other Roman denarius coin, solving the fungibility issue. Coins were small enough that they were fairly portable (albeit with risk of theft), but it did drastically improve upon the portability of previous barter systems; one didn’t have to bring a flock of chickens or a cow with you wherever you went to settle a transaction. Lastly, precious metal-minted coins solved the fundamental problem of scarcity. Gold and silver are a finite resource on our planet, despite our most ardent attempts to extract more, it remains a finite quantity. The entire quantity of all gold mined in human history would only fill four Olympic-sized swimming pools; it is one of the rarest resources on our planet. Gold being so scarce by nature gives it outstanding salability through time. Salability through time refers to the ability of a monetary good to retain its value through time. The above Roman coins have a higher value today than they did when they were first minted — gold and silver have outstanding salability through time.
Gold and Silver drastically improved early economic systems but were not without their own limitations. In respect to gold,the yellow metal is not easily divisible, if you were to pay for lunch with gold it would be cumbersome to break off a piece of a gold bar that would be commensurate with any low value transaction. Divisibility is a major drawback to any precious metal. The biggest drawback to gold, however, is that it is a physical bearer asset which can be easily stolen or confiscated. A bearer asset means that if a gold “token” is in your possession, you, by default, own it. These shortcomings of theft, portability and divisibility led to our global societies moving from physical bearer tokens (gold coins) to ledgers.
Centralized ledgers (banking) have the benefit of mitigating theft (storing wealth in a bank is more secure than your home), and it helps rectify the divisibility issue of gold coins. To solve these two issues, governments created gold certificate dollars (essentially an IOU). The idea was to keep gold in a central vault and issue the depositor a certificate that is directly redeemable for gold in direct proportion to the certificate (or dollar). If you were to deposit one ounce of gold, you would receive gold certificate “dollars” in direct proportion to your gold deposit. These paper certificates could be used to easily spend, as they were more divisible and exhibited less risk of theft — the best of both worlds! We now had money that was divisible (came in a wide variety of denominations), fungible and backed by a scarce resource (gold). This became a centralized ledger system, as we now relied on the banks to keep a ledger of what is owned. There is one glaring problem with centralized ledgers: You place all your trust in that party maintaining that ledger not to debase the “certificates” (dollars) and to keep the scarce resource (gold) that is backing the currency in direct proportion to the certificates outstanding. Sadly, this trust has been catastrophically compromised in every single example of central banking.
The above picture on the top is an early American five dollar bill. It very clearly states “Redeemable for 5 dollars of Gold Coin.” Do you notice anything different from our current $5 dollar bill? It now says “Federal Reserve Note” — this is no longer redeemable for gold. Our money is now just a piece of paper and has been since 1971 when the United States diverged from the gold standard. Scarcity, the most important characteristic of money, is now directly in control of the United States Federal Reserve (which is neither federal nor has any reserves — a conversation for another day). Gold has maintained a 2,500-year track record of keeping money valuable due to its strictly limited supply in the earth. No one, regardless of how powerful or influential, can create more. By moving to paper money, backed by nothing, we now trust one body of bureaucrats to keep our money scarce — to say they are failing at that may be the understatement of the century.
“Your ATM is safe. Your banks are safe. There’s enough cash in the financial system and there’s an infinite amount of cash in the Federal Reserve.” — Neel Kashkari, Minneapolis Federal Reserve President
“Paper money eventually returns to its intrinsic value: zero.” — Voltaire
Inflation and Wealth Destruction
It has become increasingly common to hear statements along this line of thinking: “$24 for lunch? Everything is getting so expensive! Health care, housing, insurance, education for my kids, I can barely afford to live!” To this end, it begs one very simple question: What is more likely, every good and service you are consuming is inexplicably becoming more expensive; or, is the one common denominator in all these things (money) becoming worth less? Think on this question for a moment. How could it be that nearly every good or service is becoming less affordable? Given the massive advancements in computing, engineering, automation and manufacturing throughout the last 30 years, shouldn’t things become less expensive, not more expensive?
The truth is the wealth you’ve accrued in state-issued currency is losing its value every single year. Every single year. A baseline definition of inflation may be a phenomena in which general price levels rise, and each unit of currency buys fewer goods and services. Inflation is a monetary phenomenon, not a price phenomenon. Prices go up because inflation is happening, not the other way around. If you have $1,000 today and let it sit in a checking account, next year you may only be able to purchase $950 worth of goods and services, and this loss is compounding every single year. The even more unfortunate news is that this devaluation is rapidly accelerating (losing value faster and faster). To give a simple analogy, let’s say you are a wheat farmer and the wheat market has been very profitable for you. Last season, all competing wheat farmers’ crops were destroyed by a flood; but, you alone had no losses and had a great harvest. You made a fortune due to the fact you could charge such a high price being the only game in town for wheat — we chubby Americans are willing to pay a lot more to make sure we get some wheat for our cakes. Let’s say the next year, for some inexplicable reason, wheat starts growing naturally, everywhere. Wheat is growing in people’s yards, to the point it becomes a noxious weed — wheat “ery’where.” The wheat market becomes saturated, as the supply is now ubiquitous. Your wheat now becomes worth nothing as the supply has exploded. This same phenomena is happening with our money, its paper — with infinite quantity.
It doesn’t require a PhD statistician to look at the above graph to recognize the inflection point that set off accelerating inflation. When we removed the scarce component (gold) from the dollar, it enabled printing of “infinite paper” and massive inflation ensued. This is a perpetual “get out of jail free card” for governments, as they can now just print money to meet expenditures without having to collect revenue through the arduous and contentious task of raising people’s taxes. You are being taxed, just in a different way; you are being taxed through the loss of your savings. As you can see below, this money printing trend is accelerating:
As you can see from the graph on the left, if you are holding your wealth in dollars or any other paper currency, your lifelong accrued “monetary energy” is getting diluted away and quickly. Bigger problems begin to occur when the velocity of money slows down. Velocity refers to the number of times that a unit of currency is used to purchase goods or services within a given time period. To maintain purchasing power, informed individuals have been putting their dollars into scarce assets to protect themselves. To name a few of these “flight to safety assets,” fine art, equities, real estate, precious metals and bitcoin have become favorites. A rational human has no choice; you must move your assets into a vehicle that cannot be diluted through the *theft* of time. In other words, we need a monetary good that is salable through time and that requires scarcity.
Memes can speak a thousand words:
A Critique Of CPI
The Bureau of Labor reports inflation statistics to the public using a metric called CPI — or the consumer price index. To arrive at a monthly CPI, the U.S. Department of Labor takes a weighted average of prices of various things that consumers purchase and claims to find the various proportions of different items in a typical household budget. In essence, they get to handpick what they include in this market basket of goods. A common criticism lies in the weighted average of goods they include in this basket. What is arguably underrepresented are assets. Home prices, education, equities, health care, vehicles and services to name a few. In many ways, this is analogous to a teacher telling a student to go home every month, study, take the test and just report back with the results. How do you think that report will come back? Perhaps they may come back with the yearly report of achieving 2% inflation? If you look at home prices in your area, your education expenses, how many hours needed to work to buy one share in the S&P 500 index, would you say this has been appreciating at more or less than 2%? You don’t have to know anything about economics to understand this fallacy.
Common consumer goods are, for the most part, inherently deflationary (the price naturally comes down over time); the advancements in manufacturing, automation, software, machine learning and efficiencies in supply chains make this a reality. Digital goods (Netflix subscriptions, software, etc.) are also inherently deflationary as the variable cost to produce more is essentially zero. If a company creates software, the cost to create additional copies is near zero. The only marginal cost of additional copies is the customer service aspect.
In short, electronic, technological and digital goods are inherently deflationary. It is commonly argued these things are far overweight when calculating CPI, leaving for a distorted view of reality, and, to this end, I very much agree.
A germane topic to address is that inflation is a global problem. There are seven billion people living with inflation that is even more pernicious than the United States, with hundreds of millions of global citizens experiencing hyperinflation. In 2018, for example, Venezuela experienced inflation of 130,060% — this is a population of 28 million people who have lost everything. Inflation is a humanitarian crisis.
Publicly traded companies like Tesla, Microstrategy and Square, to name but a few, have been converting cash on their corporate balance sheets to bitcoin in an effort to preserve their “economic battery.” In the background of this, bitcoin reached $1 trillion dollar market capitalization, making it the fastest moving asset in the history of humankind to reach $1 trillion.
“Cash is no longer an asset for any company, it’s a liability — it is a melting ice cube.” — Michael Saylor, CEO of Microstrategy
“In retrospect, it was inevitable.” — Elon Musk, after moving a portion of the Tesla balance sheet to bitcoin
I know the inflation issue can seem dreary and dark, but the good news is we have brilliant sunlight in the form of Bitcoin. A global, voluntary system of money that no one controls — that no one can ever control. There will only ever be 21 million bitcoin, this is mathematically imposed — no one can change it. Currency units in this system are programmatically brought into existence, and the supply is easily auditable by every person in the world. Transparency in money, at last.
Wealth Inequality In The Fiat System
Wealth inequality is one of the most destabilizing factors in any society. This can be witnessed in the French Revolution where the bourgeoisie were met with guillotines in the street. If one were to look at our current distribution of wealth, it is demoralizing at best, along with modern U.S. politics. Our politicians and citizenry seem to talk past each other, finding common ground is a radical exception. It could be posited that part of the reason we cannot find common ground in our political sphere is that we cannot agree on a common problem. Using vague, commonly perceived generalities in addressing our national financial problems, one prevailing ideology tends to cast blame at immigrants and the welfare state, while the opposing ideology aims to blame anyone with financial success and is seen as demonizing productive citizens.
If we all worked to understand one of our most destabilizing issues (money) a little better, we may realize that we have more in common than we want to believe. Our current economic system creates perverse incentives and misallocation of capital; both sides of the argument are simply trying to navigate this broken economic system. The Titanic is sinking, team red and team blue are arguing how to best arrange the chairs on the deck. A very strong argument could be made that wealth inequality has more to do with a broken economic system than any policy issue. It would be naïve to contend that a broken system of money is the only factor contributing to inequality; however, this writing will go on to show it does contribute enormously to the problem. In Bitcoin, there is a very common ethos, “Don’t trust, Verify.” Please verify this hypothesis and data for yourself:
As you can see from the above graph (top), there was a violent divergence between gains in productivity and hourly wage earner’s share of that productivity growth after 1971. The graph on the right highlights the gains of the U.S. economy realized by the top 1% since moving to limitless paper money. This highlights the fact that capital markets have drastically outpaced wage earners. Simply put, wages do not keep up with inflation. Another way to look at it is, because you are a wage earner, you haven’t had excess capital to keep in the stock market and because of this you’ve missed out on all the inflation gains that have occurred in the stock market. Now, you have to pay for other inflated assets: housing, cars, health care, and so on, and your wages have been dismal in keeping up with the rising prices. Anyone in America feeling this? Hundreds of millions of Americans. Those who can afford to invest in assets see their wealth keep pace with inflation, with those who cannot afford to invest being left behind. The reality has led to the near complete eradication of the middle class, leaving us with two economic classes: the wealthy and the poor.
Income gains for the median and lower percentile have clearly been outpaced by the upper class since moving to strictly paper money. The graph on the right is a very compelling representation of the impressive growth in real GDP per citizen but also sadly depicting those gains are not being shared by a large part of the population. To explain the wealth gap, this idea can be further supported by the below graph demonstrating the decline in wages share of the economy’s total income.
You may ask, “How does paper money contribute to this problem?” To answer that, we need to understand how the government injects liquidity (money) into the market. Economists use all kinds of esoteric terms: quantitative easing, rehypothecation, interest rate targeting, and a universe of convoluted terms and concepts the average person doesn’t have time to concern themselves with (I don’t blame you). In short, the problem lies in using money as a political tool. I subscribe to the belief that neither central bankers nor politicians have a nefarious agenda when it comes to economic management, they simply want to appear successful during their time in office. We all know the most commonly referred to indicator of U.S. financial success in a given year — the performance of the stock market, albeit to be painfully naïve. No single variable has a stronger influence on the American stock markets than the Central Bank policy and this is not even up for debate. If you are skeptical about this point, that is to be expected; however, I implore you to ask yourself one question: In 2020, during the greatest public health crisis we have seen in three generations, with nearly the highest unemployment rate in the history of the United States, how was the stock market still reaching all-time highs? Ponder that for a moment; take your time.
As you can see, unemployment reached levels just below the Great Depression, with the stock market (S&P 500 index) reaching all-time highs, or a 16% return during one of the highest periods of unemployment. In the entire history of the United States, it is estimated that 22% of the circulating US dollar was printed in 2020 — from 1776 to 2020, 22% of the money was printed in a single year.
“Stocks only go up.” — Dave Portnoy, Barstool Sports
The skinny: Our markets are not free or even close to it, and they haven’t been for some time. Inequality happens as the government uses printed money to artificially stabilize stocks and other assets without allowing the free market to adjust them to a fair valuation based on economic circumstances. People with excess capital get wealthier as “stocks only go up”; however, this is being subsidized through rising asset prices at the real cost of the poor and middle class which, sadly now, may never afford a home.
“I don’t believe we shall ever have a good money again before we take the thing out of the hands of government, that is, we can’t take them violently out of the hands of government, all we can do is by some sly roundabout way introduce something that they can’t stop.”— F.A. Hayek
We have reason to remain optimistic: Bitcoin is the sly roundabout way.
Money As A Tool Of Control: Censorship
“This is a world where you have billions of people whose bank accounts can potentially be frozen based on their opinions or ideas.” – Alex Gladstein
Cash has served as a primary means of peer-to-peer economic exchange for decades. Cash has advantages and disadvantages depending on your motivations. In many areas of the world, cash acts as a lifeline, as it can be used without surveillance, and transactions can be conducted privately. Cash can provide privacy and freedom of speech. Cash can also be used for illegal activity, and this is a universal favorite for illicit activity. One man’s privacy is another man’s illicit activity.
It has become very evident that the vast majority of transactions taking place are now digital, either through cards or web-based applications, with all of these digital applications of money being controlled by a central authority. Having a central ledger (banking) has given authoritarian governments the ability to surveil and censor money they don’t agree with. Governments around the world are working to eliminate cash from circulation and are moving to a purely digital concept. Before the conspiracy accusations are thrown around, below are a few of the thousands of headlines that have been taking place — this is no secret.
If you are a Russian dissident and maintain an opinion that is in opposition to Putin, you would prefer to support the opposition party anonymously out of fear of reprisal from the ruling regime. Putin’s regime has effectively silenced any challengers to his power through the use of several coercive tactics, including wealth confiscation. With opposition parties depleted of resources, Putin enjoys his nearly 17-year reign over Russia in a cozy echo chamber.
The Hong Kongese citizens have lived their entire lives espousing western ideals of individual freedom and democracy. Many are trying to flee the country with the impending tyrannical communist rule taking place, or at the very least, support the pro-democracy movement. In this scenario, with complete governmental control over banking, relocation becomes but a dream and democracy an idle prayer.
The list of instances in which money is being used as a tool for oppression globally is endless: Burma, Myanmar, Venezuela, North Korea and broad swathes of the Middle East. It is estimated that 4.2 billion human beings live under oppressive authoritarian governments.
Bitcoin is a censorship-resistant technology that enables human rights globally. Anyone with an internet connection can use Bitcoin. Bitcoin doesn’t care about your color, religion, political persuasion, sexual preference or value to society; Bitcoin recognizes human value. Bitcoin objectively facilitates the human-to-human exchange of value, purely independent of any other variables or factors.
Monopolies of any kind destroy societal value. Monopolies in industry stifle innovation and crush consumers. Monopolies in government stifle innovation and crush citizens. Bitcoin provides citizens a tool to exit a nation state that no longer services them. With Bitcoin, one becomes a global citizen, able to access their wealth anywhere in the world with an internet connection. The idea is that Bitcoin creates competition to monopolized money, so governments will have to treat their citizens like a valued customer again.
Bitcoin Fixes This
A common phrase in Bitcoin circles you’ll often hear is “Bitcoin Fixes this,” which is applied to a myriad of issues. For the scope of this writing, I would like to describe how Bitcoin fixes the problem of centralized ledgers that have led to inflation, wealth inequality and censorship, as previously discussed.
We’ve discussed the benefits of money being managed by a centralized ledger to that of a physical money being improved in fungibility, divisibility and security from theft, albeit with the enormous drawback of trusting that this central party will not debase the currency you’ve chosen as the battery to store your life’s energy. Bitcoin fixes this.
Bitcoin is radically scarce. The Bitcoin protocol will only ever mine 21 million bitcoin into existence — this is mathematically imposed. This also cannot be changed, as Bitcoin relies on a globally distributed system of consensus in which no one can change the rules, including you. With Bitcoin, you can independently and authoritatively validate and verify that the monetary supply is adhering to the agreed-upon protocol rules; this is called running a node. A common lexicon of speech in Bitcoin circles is “Don’t Trust, Verify.” With Bitcoin, we verify the monetary system and ensure that regulations of the protocol are being enforced.
Bitcoin is infinitesimally divisible. One bitcoin is divisible into 100 million units, these units are called satoshis, or sats for short. As it stands right now, $1 dollar can purchase around 1,700 sats. The number of sats one dollar can buy you is coming down nearly every day, demonstrating the increasing purchasing power of bitcoin and the decreasing purchasing power of dollars. I fully envision a future $1 = 1 sat; I view that as inevitable.
Bitcoin is fungible. One bitcoin is the exact same quality as any other bitcoin in existence, the software you run can independently verify that it is real and is not a counterfeit. When I say “software you run” I am referring to a Bitcoin app you use on your phone. Don’t stress; this software will only become easier to run over time — you boomers. Nothing but love for my boomers.
Bitcoin is perfectly portable. Bitcoin is data, and you can move anywhere in the world simply by carrying a thumb drive or a memorized phrase of words to access your wealth.
Bitcoin is censorship resistant and confiscation resistant. If you take possession of your private Bitcoin keys, no one can access that wealth unless you give them permission. Bitcoin guarantees the scripts you run; if you choose to send money to someone no one can stop that transaction from happening. This enables cross border commerce with low friction and low latency.
Bitcoin is programmable money. The applications that can be built out on top of Bitcoin are endless; smart contracts, escrow, streaming money and immutable messaging applications are able to be built on top of this technology stack. Bitcoin is a decentralized immutable (unchangeable) database. If you paid attention to the most recent election, shouldn’t everyone be in favor of an immutable database no one can manipulate or be accused of manipulating? There would need to be no more accusation and no more defense. Bitcoin data cannot be tampered with. Most databases are a computational “etch a sketch, Bitcoin is computational amber” (Szabo). We will vote on Bitcoin someday.
Bitcoin is global money. The human rights issues we’ve analyzed from inflation, confiscation and censorship are a global phenomenon. Bitcoin is fighting to solve some of humanity’s biggest problems (whether everyone knows it or not) — join the fight.
“The internet is uncontrollable. And if the internet is uncontrollable, freedom will win. It’s as simple as that.” — Ai Weiwei, Chinese Dissident
For more resources on Bitcoin, I would urge you to visit this website.
I would like to thank Andreas Antonopoulous, Dan Held, WTF Happened in 1971, and the United States Federal Reserve for making it easy to dunk.
This is a guest post by John Paul Klaboe. Opinions expressed are entirely their own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.
This post contains compilations of work previously written by the author andpublished separately.
The word “fiat” is growing more aggrandized in the modern lexicon, however, despite its increasing popularity it is often ill-defined or misused. I regularly observe people falsely call bitcoin a fiat currency. This is thanks, not least of all, to the layman’s poor grasp of history and money. Fiat is of Latin origin, meaning authoritative sanction; a decree, command or order. Fiat does not mean “backed by nothing” or “redeemable for nothing” or “pegged to nothing.”
The phrase “fiat lux” is a Latin reference to some of the most prolific words ever written; from the book of Genesis in the Bible, “Let there be light.” We can see here how the word is used authoritatively, there was no light, God commanded that there should be light, and there was light.
Unfortunately for us (or perhaps to our great fortune), man’s emulation of the spoken word of God carries with it far less divine authority, and thus decrees of sapien origin must be enforced by coercion, which today usually comes in the form of complex legal and judicial systems. As long as men have ruled over one another with force, there have been decrees in this manner. A decree can be as simple as making a particular day an observed holiday, likewise it can be as foolish and convoluted as saying the sky must be green on a Tuesday. Here is the insufferable nature of humanity laid bare, man can make a decree, but he cannot necessarily make it so. Mankind does not manifest ends through his words but rather via his action.
Certainly, a ruler could devote vast amounts of his kingdom’s resources toward advancing the ends of his decrees, but his means may make it no more achievable than if he had nothing at all. In fact, a very charismatic and narcissistic leader might succeed in assuaging resistance against absurd and impossible schemes of a great variety. History is full of egocentric, megalomaniacs proclaiming “fiat lux” into the darkness.
However, for our purposes, it is necessary to focus on a more particular topic, and that is the more recent, modern history of money, particularly in the United States. The word fiat is, perhaps, so widely misunderstood because the history of money is correspondingly misunderstood. In fact, by uncovering why the word “fiat” is so commonly ill-defined, we might just uncover truths of supreme importance.
Despite what you may believe, the first fiat currency of the United States, following the birth of the nation, was not in 1971, 1933 or 1913 but instead in 1792. The Coinage Act of 1792, proposed by Alexander Hamilton, established a pegged exchange rate of 15:1 silver to gold. When viewed through the modern lens, it is not at first obvious how this would be considered a fiat currency. After all, monies made from metal are not worthless paper! This simply must mean that it is impossible that a gold or silver money could be fiat! However, this is untrue; remember what the term “fiat” actually means—“by decree.”
It was by decree that the exchange rate between gold and silver coinage was decided by the United States government rather than by a free, open and voluntary marketplace. This act of price fixing places a face value premium on one coinage or the other, relative to the underlying cost of the bullion struck into coins. In this particular case, it was a premium placed on the face value of silver coins over the value of the silver bullion required to mint them. This is inherently inflationary. This premium had ultimately dilutive effects on the circulating face value of silver, as you will see.
To understand how layers of decree abstracted away our understanding of money, we must review just a sliver of the history underlying the process of transition from bimetallism to a gold standard to a pseudo-gold standard and, ultimately, to irredeemable paper notes. Our primary source for this history will be Rothbard’s “History of Money and Banking in the United States.”
At a cursory glance, it’s not a simple matter to parse how soft and expansionary commodity money policy achieved through bimetallic pegs can be severely detrimental. Nor is it necessarily a simple matter to grasp how coinage exchange rates set by decree were a rudimentary form of the fiat money in wide use today. To sort this matter out, it is helpful for us to look for an extreme historical example.
In 1860, the empire of Japan opened up its borders for the first time to free and unregulated global trade in the modern world. Traditionally, Japan had set its exchange rate on gold to silver coinage at 1:5, while international rates at the time were set to 1:15. Consider, for a moment, the implications of this decree when exposed to market forces.
The artificially cheap gold Koban coins could be exchanged for the artificially soft, silver Tenpō coins at a 200% profit. Effectively, one could take five parts silver and exchange it for gold carrying an arbitrage trade against the rest of the world’s 1:15 gold-to-silver peg. In fact, this is exactly what happened, in 1860, 4 million gold ryos (a Japanese unit of weight) left the country, equivalent to approximately 70 tons of gold.
In response, the Bakufu (the Japanese Shogunate ruling class) chose to debase the gold contents of the Koban by two-thirds, bringing it in line with the foreign (and more realistically market adjusted) gold and silver exchange rates. At this point, however, the damage had been done.
Final settlement occurred in the form of the harder money moving out of the country by the shipload. Keep this story in mind as we make our way through the various shifts in American monetary policies throughout the 19th and 20th century.
The Panic of 1792 and 1796
The First National Bank of the United States was signed into Charter by Washington (under the direction of Alexander Hamilton) which set in motion a massive inflationary speculative boom. Private investors were allowed to purchase stock in the national bank, however only a quarter of the cost had to be paid in specie (gold and silver), the other three-quarters of the cost was to be paid in government debt securities. Rampant speculation surrounding National Bank stock ensued, and it was unsustainable. The speculation would’ve liquidated itself had it been allowed to run its course.
Alexander Hamilton worked closely with a New York financier (William Seton) to authorize the purchase of $150,000 of public debt with government revenue. A first great step in the marriage of government and private enterprise. By 1792, the expansion of credit made available to speculators by the Bank of the United States (in excess of $2.17 million) nearly bankrupted the Bank of New York, and from December 29 to March 9, cash reserves for the Bank of the United States decreased by 34%, prompting the bank to not renew nearly 25% of its outstanding debt.
Speculators were then forced to sell off securities in order to satisfy outstanding debts and the deflationary contraction began. In March, Hamilton then authorized an additional $100,000 in open-market purchases of securities and heavily encouraged the bank of New York to continue offering loans, collateralized with US debt. Hamilton also promised the treasury would buy up to $500,000 of securities from the Bank of New York thus staving off the liquidation for a short time.
The following few years were characterized by even more rampant speculation and malinvestment in the bank’s stock, government debt securities and paper land claims (corresponding to the ongoing westward expansion). As is typical, new credit and capital dried up, as a war-torn Europe grew weary of American speculative instruments, and paper land claims began to depreciate in value rapidly.
In 1797, British Parliament suspended redemption of specie (which lasted until 1821) and the complete undoing of the speculative credit expansion and paper financial instrument bubble followed.
The Panic of 1819
The panic of 1819 was caused by a massive monetary expansion created by banks during the Napoleonic Wars, particularly the United States’ involvement in the War of 1812.
The War of 1812 was essentially a trade war, the far less often discussed second war with Britain who was blockading French–American trade routes in the greater context of the Napoleonic Wars. In order to procure the necessary goods required for the war, huge quantities of new bank notes were created in order to purchase government bonds.
To quote Rothbard:
“[F]rom 1811 to 1815 the number of banks in the country increased from 117 to 212; in addition, there had sprung up 35 private unincorporated banks, which were illegal in most states but were allowed to function under war conditions. Specie in the 30 reporting banks, 26 percent of the total number of banks of 1811, amounted to $2.57 million in 1811; this figure had risen to $5.40 million in the 98 reporting banks in 1815, or 40 percent of the total. Notes and deposits, on the other hand, were $10.95 million in 1811 and had increased to $31.6 million in 1815 among the reporting banks.”
Essentially, the US government was financing its war operations with massive amounts of inflated bank notes which, when called due for final settlement in specie, sparked a near nationwide bank insolvency. In 1814, the US government gave the go ahead for all banks to temporarily suspend redemption of specie, but to remain open and continue their expansion of debt unabated.
“Reporting banks increased their pyramid ratios from 3.17-to-1 in 1814 to 5.85-to-1 the following year, a drop of reserve ratios from 0.32 to 0.17. Thus, if we measure bank expansion by pyramiding and reserve ratios, we see that a major inflationary impetus during the War of 1812 came during the year 1815 after specie payments had been suspended throughout the country by government action.”
Rothbard expounds that although, during this particular point in time, there was no central bank in the United States (the National bank charter had lapsed under Jefferson) and misinformed historians often point to this as the cause of unchecked credit expansion, this monetary policy was similar to other expansionary periods which happened under the First and Second National Bank and, later, under the Federal Reserve System.
Coercion by the federal government, to secure wartime funding, drove the massive expansion of bank notes and credit, despite the lack of a central bank overseeing the process in this particular instance.
The federal government also issued large amounts of treasury notes which were “quasi-legal tender” and redeemable in specie one year after issuance. These notes took on a monetary role and were widely circulated and drove specie out of circulation (see Gresham’s Law).
“Wholesale price increases from 1811 to 1815 averaged 35 percent, with different cities experiencing a price inflation ranging from 28 percent to 55 percent. Since foreign trade was cut off by the war, prices of imported commodities rose far more, averaging 70 percent. But more important than this inflation, and at least as important as the wreckage of the monetary system during and after the war, was the precedent that the two-and-a-half-year-long suspension of specie payment set for the banking system for the future. From then on, every time there was a banking crisis brought on by inflationary expansion and demands for redemption in specie, state and federal governments looked the other way and permitted general suspension of specie payments while bank operations continued to flourish.”
All of this new money and credit, in conjunction with rising commodity prices, set off an inflationary boom in 1817, which led to the deflationary bust in 1819 as the economy was snapped back to reality.
“Contraction of money and credit by the Bank of the United States was almost unbelievable, total notes and deposits falling from $21.9 million in June 1818 to $11.5 million only a year later. The money supply contributed by the Bank of the United States was thereby contracted by no less than 47.2 percent in one year. The number of incorporated banks at first remained the same, and then fell rapidly from 1819 to 1822, falling from 341 in mid-1819 to 267 three years later. Total notes and deposits of state banks fell from an estimated $72 million in mid-1818 to $62.7 million a year later, a drop of 14 percent in one year. If we add in the fact that the U.S. Treasury contracted total Treasury notes from $8.81 million to zero during this period, we get the following estimated total money supply: in 1818, $103.5 million; in 1819, $74.2 million, a contraction in one year of 28.3 percent.”
The Panic of 1857
As is the inevitable case with all fiat currency schemes, monetary expansion was the natural outcome. Large outflows of gold and silver from Mexico, due to the favorable premium on coinage in America, led to an exchange rate debasement of 16:1 in 1834 and, by the Coinage Act of 1853, all silver denominations were diluted further again.
By the 1850s, nearly half of the states in the Union had transitioned to what was called “free banking.” An important distinction here is that “free banking,” in the context of its political rhetoric sources, was not what economists traditionally considered free banking at the time.
The system of free banking that existed during this time period allowed the government to afford banks the “general suspension of specie payments whenever the banks over expanded and got into trouble,” as pointed out by Rothbard.
This means that, during times of crisis, banks were no longer liable to redeem their outstanding paper money certificates for the underlying metals. Free banking brought “a myriad of regulations, including edicts by state banking commissioners and high minimum capital requirements that greatly restricted entry into the banking business,” explains Rothbard.
In this way, competition in banking was heavily stifled by government intervention and normally, where overextended banks would fail during a time of liquidation, this liquidation was halted. But even more concerning;
“The expansion of bank notes and deposits was directly tied to the amount of state government securities that the bank had invested in and posted as bond with the state. In effect, then, state government bonds became the reserve base upon which banks were allowed to pyramid a multiple expansion of bank notes and deposits. Not only did this system provide explicitly or implicitly fractional reserve banking, but the pyramid was tied rigidly to the amount of government bonds purchased by the banks.”
Effectively, a bank’s ability to expand its credit and monetary base was directly tied to public debt. The more debt it purchased from the government, the more new money it could create and, in tandem, the more banks made use of this financial trickery, the more governments could expand their debt as well. This ability to expand credit and essentially soft default on that debt when it came due, through the suspension of specie redemption, is very important for what came next.
Starting in 1848, the American Gold rush was in full swing. A huge supply of new gold was introduced to the market creating strong inflationary signals. Seemingly, economic conditions were good. Investors and speculators engaged in rampant overleveraging.
By the mid 1850s, the supply of new gold began to dry up and, additionally, a large shipment of gold aboard the SS Central America was lost in the midst of a heavy storm. She was carrying approximately 30,000 pounds of gold to the shores of Eastern America at the time!
In the midst of these two deflationary events, the railroad companies booming around the growing westward expansion experienced a speculative stock bubble. Thanks to the abundance of cheap credit (and latent malinvestment), many of these companies were worth considerable amounts of money on paper but had no physical assets with which to run their business. Railroad stock values peaked in July 1857 and a slow market sell off began.
The Gold Standard
The subsequent fall out from these events lasted up until the Civil War at which point virtually all specie redemption stopped. The National Bank Act of 1863 forbade the issuance of any new state bank notes, finally giving a full monopoly of monetary expansion to the federal government.
With the groundwork having already been laid for paper money experiments in the colonial area, the United States switched from bimetallism to a paper currency backed by silver specie in order to fund the Civil War effort. This was colloquially known as the “green back system.”
Following the end of the war, the United States resumed redemption of specie but ended what was known as “free silver.” By 1873, the silver value of coins had dropped so low relative to their fiat face value that the United States soft abandoned bimetallism by ceasing the free and unlimited minting of silver coins with the Coinage Act of 1873. This was largely politically unpopular and led to 20 years of political strife over the alleged prosperity caused by monetary expansion under free silver.
The Sherman Silver Act of 1890 ushered in a period of inflation by decreeing an increase in the amount of silver purchased by the US government—to the tune of 4.5 million ounces of bullion a month. This caused a sharp increase in the paper money supply of the United States and encouraged rampant speculation.
The US treasury purchased the silver bullion using a special issue treasury note which could then be redeemed for either gold or silver, and a run on the gold reserves of the United States began. Artificially overvalued silver drove gold out of circulation and into hoards.
In the metals markets, silver was now worth less than the fiat exchange rate of silver to gold. Investors would buy silver from the booming mining economy, exchange it for gold with the treasury, and then sell the gold claims for a profit. These profits were then reinvested in more silver and on the cycle went.
This continued until the treasury nearly ran out of gold. President Grover Cleveland repealed the Sherman Act to prevent further loss of federal gold reserves.
By the end of 1890, the price of silver had dropped from $1.16 an ounce to $0.69 per ounce. By early 1894, the price had dropped to $0.60. By November of 1895, US mints entirely halted all production of silver coins and outright discouraged the use of silver dollars.
Runs were made on the US treasury gold reserves—not just by silver speculators but by European financiers as well—in anticipation of a spreading global financial turmoil. Concern over the weakening financial state of the United States led to bank runs and a nationwide liquidity squeeze as the malinvestment wrought by monetary expansion began to purge.
In the midst of this man-made regulatory fiscal crisis, global commodities prices (particularly that of wheat) tanked due to a cascade of liquidations in emerging markets. In 1894, the rate for a bushel of wheat dropped from its 14.7¢ 1893 price to 12.88¢ per bushel, continuing to fall all the way to 9.92¢ in 1901. Overleveraged US farming operations dependent on high international commodity prices went belly up.
By 1900, the United States established for the first time, a gold standard.
The Panic of 1907
The panic of 1907 was a period of monetary contraction leading to a financial/banking crisis which set the tone for the creation of a central bank in the United States (The Federal Reserve, with the previous National Bank having been abolished under the Jackson Presidency).
The panic coincided with the annual harvest season where money would flow out of the cities as harvests were purchased. To compensate for this, banks would raise interest rates. Taking advantage of these new interest rates, foreign investment became increasingly attracted to the New York markets. During this time and as well across the first half of the decade, the United States saw a massive run-up of the DOW Jones (seen below).
In April 1906, San Francisco had a 7.9 magnitude earthquake, prompting a large amount of money to make its way to the west coast. In late 1906, the Bank of England also raised its interest rates, slowing foreign investment in New York City.
That same year, the Interstate Commerce Commission passed the Hepburn Act which allowed for a ceiling to be placed on railroad rates. The result was a devastating blow to the railroad securities valuations and so began the market cascade. This was followed by a collapse in the price of copper, a failure in the New York City Bond offering (June 1906), and major antitrust fines against the Standard Oil Co.
At the time, the national banking system had no ability to inject artificial liquidity into the system and, naturally, the liquidation was painful. This was much to the chagrin of many of the bankers throughout the country.
“In each of the banking panics after the Civil War, 1873, 1884, 1893, and 1907, there was a general suspension of specie payments. The panic of 1907 proved to be the most financially acute of them all. The bankers, almost to a man, had long agitated for going further than the national banking system, to go forward frankly and openly, surmounting the inner contradictions of the quasi-centralized system, to a system of central banking.”
“The Bankers found that the helpful cartelization of the national banking system was not sufficient. A central bank, they believed, was needed to provide a lender of last resort, a federal governmental Santa Clause who would always stand ready to bail out banks in trouble. Furthermore, a central bank was needed to provide elasticity of the money supply. A common complaint by bankers and by economists in the latter parts of the national banking era was that the money supply was inelastic. In plain English, this meant that there was no governmental mechanism to assure a greater expansion of the money supply—especially during panics and depressions, when banks particularly wished to be bailed out and avoid contraction. The national banking system was particularly inelastic, since its issue of notes was dependent on the banks’ deposits of government bonds at the treasury. Furthermore, by the end of the nineteenth century, government bonds generally sold on the market at 40 percent over par. This meant that every $1,400 worth of gold reserves would have to be sold by the banks to purchase every $1,000 worth of bonds—preventing the banks from expanding their note issues during a recession.”
It was following this crisis that a man named Nelson Aldrich (father-in-law of John D. Rockefeller) formed a commission to investigate and propose solutions to fix this “problem” of liquidation and money expansion.
The Federal Reserve
Nelson Aldrich proposed “The Aldrich Plan.” Congressman Vreeland (one of the bill’s coauthors) had the following to say on the proposal:
“The bank I propose…is an ideal method of fighting monopoly. It could not possibly itself become a monopoly and it would prevent other banks combining into monopolies. With earnings limited to four and one half percent, there could not be monopoly.”
It is important to remember that antitrust legislation was center stage around this time. Popularized, in particular, by the likes of the “Progressive Bull Moose’’ Theodore Roosevelt with his Sherman Antitrust Act of 1890. This framing of a central bank in the United States being necessary to prevent banking monopolies was crucial to its public acceptance. The reality of how central bank policy affected change could not be further from these claims.
Firstly, we know with absolute certainty that the measly “four and a half percent” Vreeland spoke about would fly out the window at the earliest opportunity, but the real wealth concentrating monopolization of the Federal Reserve would come in the form of monetary and credit expansion.
Secondly, artificial protections from the liquidations of malinvestment is, in effect, a legal monopoly for all beneficiaries, shielding banks from the consequences of market forces which, ordinarily, naturally direct capital allocation.
Cleverly, the Federal Reserve was set to be a private institution, and unelected bureaucrats would reside over its policy making. This was a convenient loophole to skirt the unconstitutionality of unchecked monetary expansion. Frankly, this relationship is the opposite of antitrust, as private government partnerships both create and sustain cartels via judicial and legislative capture.
The most important difference between the Federal Reserve and the national banks of the United States, which had existed in years prior, was the Fed’s ability to create the official money of the United States. Paper bank notes issued by the Fed became legal tender for both public and private debts. Notice the Constitution didn’t specifically prohibit a private institution from issuing bills of credit and the government then deeming it legal tender. For all intents and purposes, this was a deliberate obfuscation of US constitutional law.
One should note, there is very little presence of a “private institution” on these illegitimate bills of credit, they take on every role and appearance of being a government issue.
All of this was a carefully constructed facade to convince the public that the government was working to “break apart the money trust.” The public was thoroughly convinced that it was the centralization of financial power in Wall Street which caused the booms and busts actually created by government policy making. The Aldrich bill was the reform that promised to fix this problem for the American people.
As G. Edward Griffin put it in his brilliant expose, “The Creature from Jekyll Island: A Second Look at the Federal Reserve”:
“The public was, of course, outraged, and the pressure predictably mounted for Congress to do something. The monetary scientists were fully prepared to use this reaction to their own advantage. The strategy was simple: (1) set up a special congressional committee to investigate the money trust; (2) make sure the committee is staffed by friends of the trust itself; and (3) conceal the full scope of the trust’s operation while revealing just enough to intensify the public clamor for reform. Once the political climate was hot enough, the Aldrich bill could be put forward.”
Executive Order 6102 and the Emergency Banking Act
The restrictions on new money creation were eased by the FDR administration with the Federal Reserve turning over all of its gold to the treasury, under the Gold Reserve Act of 1934. One should note that monetary expansion began to increase in velocity particularly after the creation of the Federal Reserve in 1913 and into WWI.
The booming economy of the roaring twenties was a result of Mellon’s push to lower federal reserve interest rates in 1921 and 1924. The availability of cheap credit and cheap capital encouraged once again, rampant speculation.
In 1928, responding to the fear of a dangerous bubble in the stock market, the Federal Reserve began to raise interest rates. In 1929, the Fed raised the interest rates to 6% and yet still failed to stop rampant speculative activity in the markets.
Less than three months after this rate hike, came Black Tuesday. Historically, one of the worst financial crashes in the history of the United States. Mellon was a strange man. On one hand, he publicly proclaimed his disdain for economic intervention and yet, by 1930, he was already again calling for interest rate cuts (2% by mid-1930). The four-year devastation caused by the burst of this speculative bubble led to drastic reforms by the FDR administration.
The Emergency Banking Act of 1933 (EBA) was a series of reforms made by the federal government (driven by the FDR administration) to stabilize the banking system.
The act came directly on the heels of a nationwide banking holiday declared by FDR. These holidays were intended to halt the widespread bank runs. FDR made a great number of reforms during just the first year of his presidency.
The EBA was an amendment to the Trading with the Enemy Act of 1917 (TWEA) which originally gave the president power to restrict trade between the United States and foreign nations during a time of war (in particular, WWI), however, the TWEA was changed to also be usable in times of peace via a congressional amendment.
The EBA amendment was passed in a single night of chaos on the Congress floor with such haste that only a single copy was available to the House and was voted on after being read aloud. The act had two significant goals:
1. To reaffirm the Federal Reserve’s commitment to supply “unlimited currency” to banks which reopened after the end of the banking holiday
2. To establish a 100% deposit insurance for banks
All of these were temporary measures until the much more cohesive 1933 Banking Act.
The 1933 Banking Act was wide in scope, and it had many significant goals:
Creation of the FDIC
Separation of Commercial and Investment Banking
Creation of the Federal Open Market Committee (FOMC)
Reduction in competition between commercial banks
Restriction in “speculative” uses of bank credit and removal of limits on total amount of loans that could be made by member banks
Elimination of personal liability for new shareholders of national banks
Tightly regulate national banks to the Federal Reserve, requiring member banks and holding companies to make three annual reports, given to the Fed
Give national banks the same ability to establish branches in their home state as state chartered banks
Executive Order 6102 (EO 6102) was signed on April 5, 1933 (one month after the Emergency Banking Act), by President Franklin D. Roosevelt, “forbidding the hoarding of gold coin, gold bullion, and gold certificates within the continental United States.” This power was made possible by the Emergency Banking Act of 1933.
Many are aware of EO 6102 and its implications on the US markets at the time, but few realize that gold ownership actually remained illegal throughout the entirety of the Bretton Woods agreement which ran from 1944 to 1971.
“The private ownership of gold certificates was legalized in 1964, and they can be openly owned by collectors but are not redeemable in gold. The limitation on gold ownership in the U.S. was repealed after President Gerald Ford signed a bill to “permit United States citizens to purchase, hold, sell, or otherwise deal with gold in the United States or abroad” with an act of Congress…which went into effect December 31, 1974.”
Following this legislation to its logical conclusions, this means that it was actually illegal for US citizens to redeem their USD for gold held by the US Treasury under the Bretton Woods system!
EO 6102 was a direct and indefinite suspension of the redemption of specie, echoing over a century of similar policy making surrounding government-induced financial depressions. In other words, paper notes could no longer be redeemed for the gold by which it was supposedly backed. In fact, from 1933 to 1971, this settlement to the base layer of money was a right reserved only for sovereigns.
Bretton Woods and the London Gold Pool
From 1961 to 1968, Western Banks corroborated in what was known as the London Gold Pool. The United States and a handful of European nations pooled their gold resources into the London gold exchange in an attempt to stabilize the price of gold around the fixed redemption rate of $35 per troy ounce.
This monetary experiment, just like every other attempt at market intervention and stabilization (attempt to subvert free market action), failed horribly and ultimately led to the closing of the gold window by Richard Nixon in 1971.
Perhaps its best to establish a timeline of events here. In 1933, EO 6102 not only made it illegal for US citizens to hold physical gold but also effectively prohibited them from redeeming treasury notes for gold. With the outbreak of war in Europe, the London Gold Pool closed its operations in 1939, effectively stinting international gold redemption under Bretton Woods (est. 1944) until the London Gold Pool reopened in 1954.
Notice here, that during this time period (roughly 1933–1954), US gold reserves were at their all-time high. Starting in 1961, central banks began cooperating in an attempt to stabilize gold prices via the London Gold Pool by providing excess gold if demand increased and providing buy pressure if demand started to drop.
In the first half of the 1960s, the pound sterling was under significant stress from various European geopolitical crises (seen below). As a result, increasing amounts of intervention were needed from central banks to maintain the desired gold exchange rates.
It was well known by sovereign financial ministries that the United States was benefiting disproportionately via the dollar peg by exporting inflation and running deficits to benefit from the seigniorage of dollar creation. In 1965, the De Gaulle administration of France (at direction of the finance minister, Jaques Rueff) announced intentions to begin exchanging dollars for gold in an attempt to close this deficit gap and force a return to an international gold standard.
These events had significant and expected impacts on the demand and price of the gold markets, starting around 1960, a dramatic decrease in US gold reserves occurred, all the way up until the collapse of the London Gold Pool in 1968. In effect, this financial loss can be viewed as the central banks’ (both the United States and The Bank of England) attempt to stabilize the London Gold Pool.
Here we see the United States fighting the same battle previously fought by the Japanese Shogunate, caused by their artificially soft and expansionary money policy under bimetallism. Despite the suspension of redemption of specie for all but the sovereign states, artificially soft gold notes were arbitraged for a profit which could be settled in finality on the base layer money (gold specie).
In 1969, the IMF passed legislation allowing the issuance of the SDR, technically the first fiat obligation not backed by a form of gold redemption under the Bretton Woods system, and the first step toward the establishment of floating global fiat reserve currencies.
As we know, Nixon ended the convertibility of the dollar for gold in 1971 (the backbone of the Bretton Woods system) and the adjustable peg disappeared entirely in 1973.
For a far more comprehensive look at these events, I would refer you to this research piece. Hopefully I have given you enough of an overview of these historical events to get a picture of how the incentives of the system disrupt its stability. This topic is complex, and despite the fact that the USD was the backbone of the Bretton Woods system, that isn’t to say they were the only nation to benefit from inflation and market intervention.
Bretton Woods was doomed to fail because of its misaligned incentives.
The events of 1971 were yet another form of soft default on obligations, except this time, rather than suspending redemption of specie to her constituency, the United States suspended redemption for every nation state under the Bretton Woods system.
And yet, despite this decree of irredeemability for paper to gold, the face value of dollars to gold was still fixed. Historically, this price was what gave the paper notes its value in the first place, specie was the base layer of money, but paper notes allowed gold to scale in an increasingly complex and global economy. In a case where paper notes can never be redeemed for the underlying specie, the exchange value is set by decree rather than by the market.
Hence the term “fiat.”
But what’s most interesting is how so many great abstractions on top of the monetary system disrupted the common man’s ability to reason that paper notes were originally a layer above specie. Rather, he began to think of paper notes as the base layer itself. This was to the great benefit of the nation state, who found it could create for itself a great deal of funding for a whole manner of twisted machinations at the expense of its currency holders (which could be diluted en masse).
Mounting global geopolitical and local socioeconomic pressures put a tremendous amount of stress on the system to continuously debase circulating currency supply to fund the next crisis.
To better understand the consequences of indefinite suspension of settlement to the base layer, I suggest looking through my website called WTF Happened in 1971. Liquidation, which was once softened by temporary base layer settlement, has been supplanted by an indefinitely suspended expansionary system. The ripple effects continually grow in magnitude and severity as economic calculations are distorted on a global scale. Look no further than the dot com bust, the 2008 financial crisis, and the 2020 financial crisis for a glimpse at how unlimited credit expansion and expansionary monetary policy go hand in hand.
These are the inevitable results, increasing amounts of risk and leverage build up in the system, with no way to purge itself, beyond one final and total collapse.
A New Base Layer
Now that we have taken the time to properly understand the history of money, it should be obvious to us that bitcoin is not a fiat currency. In fact, it is not so tongue-in-cheek to call many aspects of modern society “fiat.” They are often, in fact, by decree rather than of an emergent and voluntary order.
It is disruption of settlement to the base layer of money, which has been co-opted so effectively over the last two centuries, that has abstracted away our ability to understand the monetary system. If you look at the markets today, the Federal Reserve’s expansion of the money supply, and the government’s ability to borrow and spend unabated, it seems to simply make no sense—that’s because it does not.
Credit expansion and the generational postponement of the liquidation of malinvestment is only possible under a system mired in numerous layers of decree over a co-opted monetary base layer. According to Ludwig von Mises, “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
The common argument against bitcoin proclaims it to be a fiat currency because it is “not backed by anything.” This abstraction assumes that all money must be redeemable for something, but this simply is not so. Gold bars are not redeemable for anything and yet they were once money. They were, in fact, the base layer of money.
Bitcoin has value because people are free and willing to exchange for it, at its spot price. It has no peg, no artificial face value, and the settlement stack cannot be given a mandatory holiday.
Bitcoin is a new base layer of money, one that, as Friedrich Hayek wrote, can “take the thing out of the hands of government.” he first global, self-clearing, real-time settled, bearer asset. One which solves the problems inherent in scaling precious metals for use at a global economic scale. Bitcoin is an economic social contract with distributed consensus surrounding the rules of play, noncompliant with co-option.
A money not prone to the pitfalls of centralized issuance and debasement. A money usable outside of the confines of centralized institutions which can rehypothecate and postpone the liquidation of notes to settlement on the base layer. A money which sidesteps the inevitable replay of events that would occur under a return to the gold standard.
Bitcoin is the first base layer money in which redemption of specie (or final settlement) cannot be suspended without consequence. The right to final settlement will not be afforded exclusively to the sovereign state, but rather, any individual may choose to become self-sovereign, by simply becoming a willing participant in the network.
Despite our storied history of shenanigans, humanity progressed forward in spite of the shaky foundations upon which our economic activity, or the means of making life worth living, was ensconced. Bitcoin is better than a return to the gold standard. Bitcoin is more than a silver squeeze..
Bitcoin is a new beginning. A new base layer. An opportunity to transition a new and better system, while the old one goes down in flames. A space for fair, open and voluntary cooperation outside the prescriptions of tyrants. A fresh start for what humanity could be instead of the unyielding fixations on what it should have been.
Bitcoin is not man commanding “Fiat Lux”, but rather a genius example of how he makes it so.
This post contains compilations of work previously written by the author andpublished separately.
This is a guest post by Heavily Armed Clown. Opinions expressed are entirely their own and do not necessarily reflect those of BTC, Inc. or Bitcoin Magazine.