UNDERSTANDING OUR CURRENT MONETARY SYSTEM AND BITCOIN’S VALUE PROPOSITION

I once heard a story that set me on my journey to try and understand money. It goes something like:

Imagine a tourist comes to a small, rural town and stays at the local inn. As with any respectable place, they are required to pay 100 diamonds (that’s what the town uses as money) as a damage deposit. The next day, the inn owner realizes that the tourist has hastily left town, leaving behind the 100 diamonds. Given that it is unlikely the tourist will venture back, the owner is delighted at this turn of events: a 100 diamond bonus! The owner heads to the local baker and pays off their debt with this extra money; the baker then goes off and pays off their debt with the local mechanic; the mechanic then pays off the tailor; and the tailor then pays off their debt at the local inn!

This isn’t the happy ending though. The next week, the same tourist comes back to pick up some luggage that had been left behind. The inn owner, now feeling bad for still having the deposit and liberated from paying off their debt to the baker, decides to remind the tourist of the 100 diamonds and hand them back. The tourist nonchalantly accepts them and remarks “oh these were just glass anyways,” before crushing them under his feet.

A deceptively simple story, but always hard to wrap my head around it. There are so many questions that come up: if everyone in the town was in debt to each other, why couldn’t they just cancel it out (coordination problem)? Why were the townsfolk paying for services to each other in debt — IOUs — but the tourist was required to pay money (trust problem)? Why did no one check whether the diamonds were real, and could they have even if they wanted (standardization/quality problem)? Does it matter that the diamonds weren’t real (what really is money then)?

“The purpose of studying economics is to learn how not to be deceived by economists.” — Joan Robinson

INTRODUCTION

We are in the midst of a poly-crisis, to borrow from Adam Tooze. As cliché as it sounds, modern society is a major inflection point across multiple, interconnected fronts. Whether it is the global economic system — the U.S. and China playing complementary roles as consumer and producer respectively — the geopolitical order — globalization in a unipolar world — and the ecological ecosystem — cheap fossil fuel energy fueling mass consumption — the foundations atop which the past few decades were built are permanently shifting.

The benefits of this largely stable system, although unequal and at great cost to many social groups, such as low inflation, global supply chains, a semblance of trust, etc., are quickly unraveling. This is the time to ask big, fundamental questions, most of which we have been too afraid or too distracted to ask for a long time.

The idea of money is at the heart of this. Here I don’t mean wealth necessarily, which is the subject of many discussions in modern society, but rather the concept of money. Our focus is typically on who has how much money (wealth), how we can get more of it for ourselves, asking is the current distribution fair, etc. Underneath this discourse is the assumption that money is a largely inert thing, almost a sacrilegious object, that gets moved around every day.

In the past few years, however, as debt and inflation have become more pervasive topics in mainstream discourse, questions around money as a concept have garnered increasing attention:

What is money?
Where does it come from?
Who controls it?
Why is one thing money but the other isn’t?
Does/can it change?

Two ideas and theories that have dominated this conversation, for better or for worse, are Modern Monetary Theory (MMT) and alternative currencies (mostly Bitcoin). In this piece, I will be primarily focusing on the latter and critically analyzing the arguments underpinning the Bitcoin standard — the theory that we should replace fiat currency with Bitcoin — its potential pitfalls, and what alternative roles Bitcoin could have. This will also be a critique of neoclassical economics which governs mainstream discourse outside the Bitcoin community but also forms the foundation for many arguments on top of which the Bitcoin standard rests.

Why Bitcoin? When I got exposed to the crypto community, the mantra I came across was “crypto, not blockchain.” While there are merits to that, for the specific use-case of money especially, the mantra to focus on is “Bitcoin, not crypto.” This is an important point because commentators outside the community too often conflate Bitcoin with other crypto assets as part of their critiques. Bitcoin is the only truly decentralized cryptocurrency, without a pre-mine, and with fixed rules. While there are plenty of speculative and questionable projects in the digital asset space, as with other asset classes, Bitcoin has well established itself to be a genuinely innovative technology. The proof-of-work mining mechanism, that often comes under attack for energy use (I wrote against that and explained how BTC mining helps clean energy here), is integral to Bitcoin standing apart from other crypto assets.

To repeat for the sake of clarity, I will be purely focusing on Bitcoin only, specifically as a monetary asset, and mostly analyzing arguments coming from the “progressive” wing of Bitcoiners. For most of this piece, I will be referring to the monetary system in Western countries, focusing on the Global South at the end.

Since this will be a long, occasionally meandering, set of essays, let me provide a quick summary of my views. Bitcoin as money does not work because it is not an exogenous entity that can be programmatically fixed. Similarly, assigning moralistic virtues to money (e.g. sound, fair, etc.) represents a misunderstanding of money. My argument is that money is a social phenomenon, coming out of, and in some ways representing, socioeconomic relations, power structures, etc. The material reality of the world creates the monetary system, not vice versa. This has always been the case. Therefore, money is a concept constantly in flux, necessarily so, and must be elastic to absorb the complex movements in an economy, and must be flexible to adjust to the idiosyncratic dynamics of each society. Lastly, money cannot be separated from the political and legal institutions that create property rights, the market, etc. If we want to change the broken monetary system of today — and I agree it is broken — we must focus on the ideological framework and institutions that shape society so we can better use existing tools for better ends.

Disclaimer: I hold bitcoin.

CRITIQUE OF THE CURRENT MONETARY SYSTEM

Proponents of the Bitcoin standard make the following argument:

Government control of the money supply has led to rampant inequality and devaluation of the currency. The Cantillon effect is one of the main drivers behind this growing inequality and economic distortion. The Cantillon effect being an increase of money supply by the state favors those who are close to the centers of power because they get access to it first.

This lack of accountability and transparency of the monetary system has ripple effects throughout the socioeconomic system, including decreasing purchasing power and limiting the saving capabilities of the masses. Therefore, a programmatic monetary asset that has fixed rules of issuance, low barriers to entry and no governing authority is required to counter the pervasive effects of this corrupt monetary system which has created a weak currency.

Before I begin to assess these arguments, it is important to situate this movement in the larger socioeconomic and political structure we live in. For the past 50-odd years, there is considerable empirical evidence to show that real wages have been stagnant even when productivity has been rising, inequality has been surging higher, the economy has been increasingly financialized which has benefited the wealthy and asset owners, financial entities have been involved in corrupt and criminal activities and most of the Global South has suffered from economic turmoil — high inflation, defaults, etc., — under an exploitative global financial system. The neoliberal system has been unequal, oppressive and duplicitous.

During the same period, political structures have been faltering, with even democratic countries having fallen victim to state capture by the elite, leaving little space for political change and accountability. Therefore, while there are many wealthy proponents of Bitcoin, a significant proportion of those arguing for this new standard can be seen as those who have been “left behind” and/or recognize the grotesqueness of the current system and are simply looking for a way out.

It is important to understand this as an explanation to why there is an increasing number of “progressives” — loosely defined as people arguing for some form of equality and justice — who are becoming pro-Bitcoin standard. For decades, the question of “what is money?” or the fairness of our financial system has been relatively absent from mainstream discourse, buried under Econ-101 fallacies, and confined to mostly ideological echo chambers. Now, as the pendulum of history turns back towards populism, these questions have become mainstream again, but there is a dearth of those in the expert class that can sufficiently be sympathetic towards, and coherently respond to, people’s concerns.

Therefore, it is critical to understand where this Bitcoin standard narrative emerges from and to not outrightly dismiss it, even if one disagrees with it; rather, we must recognize that many of us skeptical of the current system share a lot more than we disagree upon, at least at a first principles level, and that engaging in debate beyond the surface level is the only way to raise collective conscience to a stage that makes change possible.

IS A BITCOIN STANDARD THE ANSWER?
I will attempt to tackle this question at various levels, ranging from the more operational ones such as Bitcoin being an inflation hedge, to the more conceptual ones such as the separation of money and The State.

BITCOIN AS AN INFLATION HEDGE
This is an argument that is widely used in the community and covers a number of features important to Bitcoiners (e.g., protection against loss of purchasing power, currency devaluation). Up until last year, the standard claim was that as prices are always going up under our inflationary monetary system, Bitcoin is a hedge against inflation as its price goes up (by orders of magnitude) more than the price of goods and services. This always seemed like an odd claim because during this period, many risk assets performed remarkably well, and yet they are not deemed as inflation hedges in any way. And also, developed economies were operating under a secular low inflation regime so this claim was never really tested.

More importantly though, as prices surged higher over the past year and Bitcoin’s price plummeted, the argument shifted to “Bitcoin is a hedge against monetary inflation,” meaning that it doesn’t hedge against a rise in the price of goods and services per se, but against the “devaluation of currency through money printing.” The chart below is used as evidence for this claim.