Broken Money

1. Money evolved from ledgers to commodity-based systems, with gold emerging as the dominant form

"Gold has maintained a stock-to-flow ratio of between 25x and 100x throughout modern history, generally averaging around 50x or above, and briefly falling no lower than 16x during the Gold Rush in the mid-19th century."

Origins of money. Money began as simple ledgers in ancient civilizations, evolving into commodity-based systems as trade expanded. Various items served as proto-money, including shells, beads, and salt. Over time, precious metals, particularly gold and silver, emerged as dominant forms of money due to their scarcity, durability, and divisibility.

Gold's supremacy. Gold ultimately won out over other commodities because:

• Highest stock-to-flow ratio (annual production/existing supply)
• Durability and resistance to corrosion
• Dense value relative to size and weight
• Global recognition and acceptance

Monetary attributes. Ideal money should be:

• Divisible
• Portable
• Durable
• Fungible
• Verifiable
• Scarce

2. Banking innovations centralized control of money and increased the speed gap between transactions and settlements

"The combination of these actions shows why the question of 'who controls the ledger' is very important. It also shows how quickly the answer to the question can change."

Banking evolution. The development of banking systems, including double-entry bookkeeping and fractional reserve banking, led to increased centralization of money control. Key innovations:

• Proto-banking and hawala systems
• Double-entry bookkeeping in Renaissance Italy
• Fractional reserve banking
• Central banking

Speed gap emergence. The invention of telecommunication systems in the 19th century created a significant gap between the speed of transactions and settlements:

• Transactions could occur at the speed of light
• Physical gold settlements remained slow
• This gap empowered banks and central banks
• Led to increased abstraction and financialization of economies

3. Global monetary orders shifted from gold standards to fiat currencies, concentrating power in central banks

"By 1999, Switzerland was the longest remaining country on a gold standard, having dropped their gold standard in 1999. In most of the world it was gone far earlier during the 20th century."

Gold standard era. The international gold standard dominated from the 1870s to World War I, providing a stable global monetary system. Key features:

• Currencies pegged to specific amounts of gold
• International trade settled in gold
• Limited ability for governments to manipulate money supply

Bretton Woods system. Post-World War II, the Bretton Woods system established:

• U.S. dollar as world reserve currency
• Dollar pegged to gold at $35/oz
• Other currencies pegged to the dollar

Fiat currency era. The collapse of Bretton Woods in 1971 led to the current fiat currency system:

• No backing by physical commodities
• Central banks have full control over money supply
• Increased monetary flexibility for governments
• Persistent inflation and currency devaluation

4. Fiat currency systems lead to persistent inflation and financialization of economies

"By hand-waiving away precious metals or any sort of natural constraint as an unnecessary or clumsy way to maintain discipline of the public ledger, they miss a key aspect of why commodity monies have stood the test of time for thousands of years: because nobody can instantly make more of them even when they have a seemingly good reason to do so."

Inflationary bias. Fiat currency systems inherently lead to persistent inflation:

• Central banks target positive inflation rates (e.g., 2% annually)
• Money supply grows faster than economic output
• Purchasing power of currencies decreases over time

Financialization effects:

• Increased speculation and asset bubbles
• Shift from productive investments to financial engineering
• Growing wealth inequality
• Monetization of previously non-monetary assets (e.g., real estate)

Long-term debt cycles. Fiat systems enable the buildup of unsustainable debt levels:

• Private sector debt accumulation during economic expansions
• Public sector debt expansion during crises
• Eventual debt restructuring or inflation to reduce debt burden

5. Bitcoin represents a revolutionary, decentralized form of digital money resistant to censorship and debasement

"Bitcoin is a distributed public ledger that some people have referred to as 'triple entry bookkeeping.' It's a protocol that allows all participants around the world to come to a consensus on the state of the ledger every ten minutes on average."

Bitcoin's key innovations:

• Decentralized, peer-to-peer digital cash system
• Solves the double-spending problem without intermediaries
• Fixed supply of 21 million coins
• Proof-of-work consensus mechanism

Bitcoin as digital gold:

• High stock-to-flow ratio
• Censorship-resistant
• Globally accessible
• Easily verifiable and divisible

Monetary policy:

• Predetermined issuance schedule
• Block reward halving every ~4 years
• Decreasing inflation rate over time

6. The Lightning Network and other layers built on Bitcoin enhance its scalability and utility

"The Lightning network is a series of 2-of-2 multi-signature smart contracts that run on top of the Bitcoin base layer. These channels are peer-to-peer and can support many transactions over time for each base layer transaction."

Lightning Network benefits:

• Enables fast, low-cost micropayments
• Increases Bitcoin's transaction throughput
• Enhances privacy for small transactions
• Allows for machine-to-machine payments

Other Bitcoin layers:

• Sidechains (e.g., Liquid Network)
• Federated networks (e.g., Fedimint)
• Smart contract platforms (e.g., RSK, Stacks)

Layered scaling approach:

• Preserves base layer decentralization and security
• Allows for different optimizations at each layer
• Mimics structure of traditional financial systems

7. Proof-of-work consensus provides Bitcoin with an unforgeable history, unlike proof-of-stake systems

"Energy expended per block not only secures the UTXOs [transactions] belonging in that block but also retroactively secures all global UTXOs that occurred in past blocks. The reason for this is because it would be impossible to revert past UTXOs without reverting the current block first. Each new block effectively 'buries' all existing UTXOs under its weight."

Proof-of-work advantages:

• Creates an unforgeable, objective history
• Requires real-world resources (energy) to secure the network
• Resistant to Sybil attacks and collusion
• Allows nodes to leave and rejoin without trust

Proof-of-stake limitations:

• Relies on circular logic for determining the correct chain
• More complex and prone to centralization
• Lacks unforgeable costliness in its history
• Requires ongoing trust in the network

Importance of energy input:

• Serves as a neutral arbiter of truth
• Connects the digital realm to physical reality
• Enables truly decentralized consensus

8. Bitcoin's energy usage is limited by its utility and primarily consumes stranded energy resources

"Bitcoin's energy usage in the long run is strictly limited by the utility it provides to users, and that Bitcoin primarily consumes stranded energy that would otherwise be wasted."

Energy usage constraints:

• Miner revenue (block subsidies + transaction fees) limits total energy expenditure
• Declining block subsidy reduces Bitcoin's energy intensity over time
• Long-term energy usage will be determined by transaction fees and network adoption

Stranded energy utilization:

• Bitcoin miners seek out cheapest available electricity
• Often use excess renewable energy or flared natural gas
• Can improve grid stability and incentivize renewable energy development

Energy usage context:

• Currently less than 0.1% of global energy consumption
• Comparable to or less than many other industries (e.g., gold mining, banking system)
• Potential for increased efficiency through layer-2 solutions and technological improvements

Last updated: July 21, 2024