There are only two Monetary SoVs Today: Gold and Bitcoin
This is not investment advice. Bitcoin is highly volatile. Past performance of back-tested models is no assurance of future performance. Only invest what you can afford to lose. You must decide how much of your investment capital you are willing to risk with Bitcoin. No warranties are expressed or implied.
Wealth of a Certain Type
Money is a universal intermediate good used as a form of wealth. People use it as the connector between other goods and services, and as a way to resolve debts. The first well-documented money was accounted for in Babylonian temples in the form of barley. You see already from this, that money has aspects of virtuality, and it has a definition as an accounting unit as well as serving as a medium of exchange and a store of value for delayed usage.
Money 0.x took the form of grain, shells, even cattle, and other commodity objects of varying scarcity. Money 0.x was suited for hunter/gatherer societies and early-stage agriculture and trading requirements.
Metallic money, Money 1.0, dates from before 1000 BC and has included gold, silver, copper, and various alloys of these. Gold and silver work pretty well in terms of Aristotle’s four attributes of durability, portability, divisibility, and scarcity. A fifth attribute is fungibility, the ability to exchange one for another. Standardized coins of the realm addressed this, but coins are subject to debasement including filing and clipping. Also, coins issued from different private or government mints would require weighing and an assay for purity in order to compare their intrinsic value.
Money 1.0 was suited for larger-scale agricultural societies with nobility, armies, and the need for defense. Double-entry bookkeeping developed to support trade and commerce over a distance, and letters of credit backed by bank deposits could be supported.
The rise of the industrial age and major trading empires in the 18th and 19th centuries, and the concomitant wars, put pressure on the gold-based monetary systems in place.
The abandonment of precious metal standards was accelerated by World War I, the Depression, and World War II. This caused countries to abandon their gold pegs during wartime, and later restore them, often at a different level. Post WW2 a US-dollar pegged fixed exchange rate system was instituted by the free world. The US dollar was still gold-backed for purposes of foreign trade, although US citizens were forbidden to own gold since 1933.
Fiat, unbacked by Gold
A fully fiat system, Money 2.0, followed as America’s global lead required more and more inflation of the dollar supply to support world trade. The Vietnam War aggravated the situation. In 1971 Nixon took the US off the gold standard and since that time, foreign exchange markets have been primarily floating.
At present no national currencies are backed by gold reserves, although central banks or national treasuries retain gold and hold other nations’ currencies. They are backed by the power of the government, including its taxation power and ability to issue bonds into the marketplace.
If Money 0.x was suitable for primitive agricultural societies and Money 1.0 for feudal agricultural societies and early capitalism, Money 2.0 was the monetary technology for large scale state and capital-driven industrialization.
Some nations tie their currency directly to the US dollar. While there are some 180 national fiat currencies, 66 of these are tied to the USD (US $). Most fiat is already overwhelmingly digital, less than one-sixth is in the form of physical currency.
There are three primary multi-national currencies, the USD as a defacto reserve asset and the linchpin of the floating foreign exchange system and of trade, and the Euro and the SDR. The Euro is used by a large number of European nations and is managed by its own central bank.
The SDR (special drawing rights) is a transnational currency used between major national central banks and international agencies, and is managed by the International Monetary Fund. It is constructed as a basket of several currencies with the largest weight going to the USD and Euro and with the UK pound, Japanese yen, and Chinese yuan as additional components. It was designed as a backstop, particularly for banking crises and other crisis situations.
Is unbacked fiat a less stable situation than a gold standard? Certainly. Severe inflation and hyperinflation does not exist with a gold standard. Not that the gold standard was perfect, it had trouble supporting rapid growth in an economy for example. But since it was abandoned we have seen an increase in monetary and financial crises, and global debt is exploding. Many countries have endured runaway inflation.
Central banks don’t typically create money directly, it is done by the banking system, but central banks have pushed rates down to near zero or below in order to make money ‘cheap’ and encourage borrowing from banks (banks create money as they make loans, in a fractional reserve or equity capital based system).
Money 3.0 arrived in 2009
Now we are post-industrial, in the second generation of the Information Age. Bitcoin represents the most modern form of monetary technology. It encodes energy into secure information with intrinsic value, a purely digital asset. Money can now represent pure information, cryptographically created and secured, and stored right in the ledger.
The ledger technology is new as well. While digital fiat is still the default, it relies on 500-year old technology of double-entry centralized ledgers. Bitcoin is not only entirely digital, it uses highly decentralized triple entry ledgers with records kept by the two counterparties to any transaction and cryptographically hashed into the blockchain by miners as the neutral authority. Everything is third party witnessed or notarized by the miner that commits a block of valid signed transactions and is stored as thousands of copies running Bitcoin software on full Bitcoin nodes.
Although Bitcoin is purely virtual and held in a decentralized database (widely replicated time chain or blockchain), it best adheres to the Aristotelian attributes required of money when compared to fiat currencies and gold. As such, it represents a profound advance in the technology of money.
Table 1. Compares gold, fiat, and Bitcoin against the four Aristotelian attributes of money, plus fungibility (one $100 is as good as another). Bitcoin is superior in all aspects. It also is a private money, with no state required to issue it, and is inherently designed for global use. The Bitcoin ledger is quasi-eternal. Bitcoin can be moved across the globe in large amounts in an hour, but can also be divided into very small units. Its scarcity is absolute, with a maximum of 21 million Bitcoin, making it extremely useful as a Store of Value. It is fully fungible, one Bitcoin is as good as another (once it has been in existence for a few blocks of 10 minutes duration each).
Now we have the technology for Money 3.0, instantiated in the form of Bitcoin. It meets the five criteria better than either gold or fiat currency. What it is missing is broad acceptance, but Bitcoin’s persistence as new technology for over a decade (Lindy effect) and its rapid rise in value since introduction is driving increased adoption.
Also driving increased adoption are continued careful enhancements in the Bitcoin Core software and protocols and the growth of a cryptocurrency financial system. Second-layer and side chain technology such as Lightning and Liquid and wrapped Bitcoin increase the usability and scalability for Bitcoin applications requiring quick transfer of small amounts.
Figure 1. Bitcoins per USD $100. The time axis is in Block Years of 52,500 Bitcoin blocks, each is slightly shorter than a calendar year. Bitcoin’s value has grown from less than a penny to over $10,000 during the past decade. It crossed the $100 line during its first five years. The blue line shows the inverse of BTC/USD, that is $100 USD/BTC price, and the green line is a simple Lindy model fit with Bitcoin price growing (USD falling relative to BTC) as the 5.29th power of Block years elapsed.
Bitcoin has rapidly become established as a significant asset as a result of its over four orders of magnitude increase in price during the last decade. The chart below shows how the fiat dollar has fallen, when measured in terms of Bitcoin, plotted as the value of a $100 bill in Bitcoin terms. In 2011, after the first two years of Bitcoin’s existence, you could buy around 100 Bitcoins with a Benjamin. Now you need over 100 Benjamins to buy a Bitcoin.
Fortunately, Bitcoin has smaller denominations known as Sats (for Satoshi Nakamoto). There are 100 million Sats per Bitcoin, so now $100 will buy you almost 1 million Sats. A dollar is worth about 9,000 Sats currently.
How does Bitcoin compare to Global M1?
According to the OECD, the narrow M1 money supply of the 37 OECD developed nations doubled from 2012 to 2020. The narrow money measure M1 is a better comparison with Bitcoin as a core asset since M2 reflects large amounts of debt creation and the Bitcoin and cryptocurrency lending markets (DeFi) are in early days still.
Thus it is more appropriate to use M1 as the most liquid of the money supply measures, in comparison to Bitcoin, which is an exceedingly liquid asset. US M1 was $5.58 trillion at the end of September 2020, up $1.6 trillion (around 40% !) from $3.96 trillion at the end of 2019. Now that’s monetary supply inflation. Obviously, this is due to the extraordinary assistance measures rolled out to try to counteract the COVID-19 recession.
The total market cap of the 18.5 million Bitcoin currently in existence is around $200 billion, around 28 times smaller or under 4% of the US M1 money supply value. Let’s see how this stacks up against all national money supplies. According to VisualCapitalist, the M1 money supply globally is $35 trillion, of which only $6.6 trillion is in the form of physical currency and coins.
So at about $200 billion market cap, Bitcoin represents around 3% of the physical currency amount and only 0.6% of the global M1 amount. Physical currency is closer to being an asset than M1, although a depleting one, and may even be the better comparison.
Bitcoin’s supply increased drastically during its first decade, but due to the unique Halving schedule, its annual inflation in supply is under 2% and will drop to less than 1% in 2024 and less than 1/2% in 2028 on a relentless march toward 0%. The new supply issuance rate from mining is cut in half every four years (every 210,000 Blocks, precisely).
So it is quite likely that given its constrained supply, Bitcoin’s price could more than quadruple in global fiat terms the next eight years as we go through the next two Halvings, even if its adoption were not to increase. If Bitcoin were to grow in popularity to equal 10% of the value of current M1, it would need to increase a factor of 18 in price or over $180,000 per Bitcoin, and actually more since M1 increases with time.
M1 Jumps: Why is Price Inflation Limited?
The M1 money supply jumped 40% this year in the US, so why are prices not up 40% (yet)?
Velocity and Savings.
We have been in a slow-growth economy since the Great Recession and now have had the second very big shoe drop with the Covid Recession.
Where does all the new M1 go? So far into Wall Street asset markets mostly. Main Street’s real economy demand has been weak for over a decade, as a result of weak demographics, automation, and flat working and middle-class real incomes.
And in 2020, GDP has fallen rapidly with the spread of the coronavirus CoV-SARS-2. The population has cut spending and increased its savings. The velocity at which money turns over per annum has dropped drastically, around 30% in a single quarter for M1 velocity!
Figure 2: Rapid decrease in Velocity of M1 Money Stock from Q2 2019 to Q2 2020
Since growth in the money supply is essentially a function of bank lending, and banks have tightened credit standards, new reserves that are created by the Fed do not find their way into the real economy all at once. And just look at the Covid relief funds, some portion of which did inject direct new money into the system through payments to individuals. Primarily they replaced lost income from unemployment, and some have also found its way into asset markets (stocks, even Bitcoin) as well as going towards savings and debt repayment.
If the economy picks up as the Fed wishes, inflation will increase. The Fed is looking to push it up above 2%, and to do that, it has to grow the money supply significantly faster than that given the tendency toward falling prices due to demographics, technology advances, and debt destruction.
Let’s assume the global M1 supply doubles again in the next 8 years as it did in the prior eight. This is a very conservative assumption since the US just created close to 5 years’ worth of M1 earlier this year. The total number of Bitcoin will only increase by 9.375%, algorithmically enforced from the last Halving in May of this year, and the next two occurring in early 2024 and early 2028. So just based on supply considerations without considering things like new Bitcoin ETFs and big institutional money coming in, the price should go up by a factor 1.8 or so relative to global M1 in developed countries. That’s a compounded 7.8% between now and early 2028.
From the beginning of 2013 until the beginning of 2020, the US M1 money supply grew at the same compounded rate of 7.8%. This was prior to the big jump in response to COVID-19.
Going forward, Bitcoin can be thought of as a perpetual zero-coupon bond whose effective yield is related to the inflation in the global M1 money supply. There is a correction for Bitcoin’s supply increase, but that correction is rapidly shrinking toward zero.
By 2024 Bitcoin’s supply inflation rate will drop from its present 1.8% to 0.8%, so relative to US M1, it will be similar to having a 6%, growing to 7%, effective yield zero-coupon. Where can you find such a yield today with no credit risk? Bitcoin’s price has high volatility, but there is no possibility of default.
Gold is also a sort of perpetual zero-coupon, so let’s now take a look at Bitcoin compared to gold.
Gold is still the Default Store of Value
The world’s gold is valued at around $12 trillion at its current price and over $2 trillion of that is in the form of official government holdings.
If Bitcoin were to equal 1/10 of global gold value, its price would have to increase to around $60,000 or around 1 kilogram of gold per Bitcoin.
Why might this happen? See Table 1. Bitcoin is a superior form of money to gold in all of the Aristotelian attributes, and in fungibility as well. The technology of money has advanced. Younger generations are increasingly comfortable with mobile money and cryptocurrencies in comparison to gold.
Long-term models relative to the gold price (https://medium.com/the-capital/bitcoins-value-vs-gold-1962f3323f92) show that Bitcoin has been rising rapidly relative to gold, by around the fourth power of time elapsed since Bitcoin was first created. With such a power law model for Bitcoin’s value versus gold, one projects a value over 3 kilograms of gold per Bitcoin by the end of the decade, up from 6 ounces today.
Other Wealth Stores
The primary stores of wealth in the world are real estate (including land) and paper assets in the form of stocks and bonds.
There is a house in a neighborhood near mine with an offering price above $2 million. The owner has indicated they will accept cryptocurrency in payment. Some real estate is already being tokenized as a way to broaden ownership, somewhat in the style of real estate investment trusts.
But real estate is highly individual (not fungible for the most part). It is easier to compare Bitcoin with equities. A website assetdash.com compares Bitcoin’s valuation to the market capitalization of the world’s largest companies. You may be very surprised to see that as of October 17, 2020, Bitcoin’s market cap is in position #31 (although it is not a company) and that it rivals that of well known large companies such as Coca Cola, Pfizer, and the Bank of America and is larger than that of Merck, ATT, and Pepsi.
Table 2. Market cap for Bitcoin and some large corporations of roughly similar market capitalization of around $200 billion.
Now we even have corporations putting significant portions of their treasury funds into Bitcoin. You can track them here: https://bitcointreasuries.org. Some of these are investment vehicles, the best known being Grayscale’s GBTC, which trades like an ETF and holds over 2% of all Bitcoin, worth over $4 billion, in trust for investors. Galaxy Digital Holdings in Canada holds 0.08% of all Bitcoin and was established as a cryptocurrency enterprise.
But others are corporations who have decided to invest to strengthen their financial position. MicroStrategy (MSTR) has gone all-in with its treasury. The CEO Michael Saylor is doing the podcast circuit and saying they studied very carefully (and established their position carefully) before committing the major portion of their cash holdings to Bitcoin. They invested $425 million.
Square has invested $50 million in Bitcoin, and privately-held Stoneridge purchased $115 million’s worth. We expect Square will increase their holdings over time.
Bitcoin rivals major corporations for market cap, and medium-sized to large corporations are adopting Bitcoin for their treasury holdings, substituting Bitcoin for commercial paper and government paper.
”A Medium of Exchange possessing a fixed purchasing power is a self-contradictory concept” — Joseph T. Salerno
The site coinmarketcap.com lists 7434 cryptocurrencies. Almost all are weak as a store of value.
The value in Bitcoin comes from a combination of unrivaled security (hashrate and Proof-of-Work mining) and scarcity (absolute 21 million cap) and network effects. The #2 cryptocurrency, Ethereum, has just 1/5 of Bitcoin’s market cap, in spite of its importance for DeFi and token creation. In fact, Bitcoin has 59% of all cryptocurrency value, Ethereum 12%, and all 7432 others, including stable coins, share 29%, just half of what Bitcoin alone possesses.
All the national fiats in the world, and the thousands of cryptocurrencies, are designed as mediums of exchange and do not hold value well. Overwhelmingly they have inflationary money supply policies and easy creation methods, including the printing press, quantitative easing, and airdrops.
Bitcoin is constantly criticized on medium of exchange grounds. There are three main criticisms:
- It doesn’t process enough transactions.
- Transactions fees are too high.
- It uses too much electricity.
All three can be addressed by looking at Bitcoin as a store of value first and foremost. There are second layer and side-chain solutions such as Lightning and Liquid and wrapped Bitcoin that allows for many more small transactions. One can batch these up and, at chosen time intervals, commit a single larger transaction back to the original Bitcoin blockchain (time chain).
Why use a store of value to buy coffee? Use a weaker currency, a medium of exchange like the US dollar or an altcoin or stable coin crypto.
Transaction fees are very reasonable now, sometimes they have become too high. In that case, one can use a compatible solution as outlined above or use another cryptocurrency such as a stable coin. Bitcoin doesn’t compete against Visa for smallish transactions so much as it does against the international SWIFT network for larger transfer amounts. In that case, SWIFT and traditional payment systems such as Western Union have much higher fees and take several days for transfers to complete.
I have addressed Bitcoin’s electricity usage elsewhere, it is a fraction of the energy used in gold mining, for example. It is growing rapidly, but the industry has been out front in shifting to greener sources such as hydropower and, more recently, natural gas in the field that would otherwise be flared off. Countries and regions can and do limit electricity access for Bitcoin miners, but crypto mining has the advantage that it can be easily halted during periods of peak commercial and residential load and restored when other power demands are low.
Bitcoin’s Proof-of-Work consensus algorithm is a solid feature, not a bug. It imparts value. Bitcoin encapsulates energy into a highly secure store of value on a decentralized triple entry ledger.
Liquid or Solid?
Liquid and solid are two distinct phases of matter, and they have different purposes. Liquid corresponds to a medium of exchange. Solid corresponds to a store of value.
We talk about liquidity in the economy and in the banking system and credit markets, and on foreign currency, stock, and commodity exchanges.
We talk about solid investments as more stable, less risk. A solid investment is designed to protect, store, and grow wealth.
If you want something highly liquid, use a national fiat or a stable coin or central bank digital currency (CBDC). (Remember though that they will be tracking transactions centrally with a CBDC). Or use another cryptocurrency.
If you want something solid, that provides a long-term standard store of value, that you can count on, you can store wealth in Bitcoin.
Bitcoin is that solid long-term savings vehicle, for people with low time preference, with a long-term investment horizon. It is not designed, it was not designed by Satoshi, for twitchy fingers. It was designed because the Money 2.0 fiat system is increasingly creaky; it rests on weak foundations. And Bitcoin was designed because the technology made it possible to create a new and better Money 3.0 for the 21st century.