Broken Money
I just finished reading Lyn Alden’s Broken Money and highly recommend it to anyone interested in the history of money, the evolution of and intricacies behind our current financial system, and Bitcoin. I believe it will ultimately be viewed as a seminal text in clarifying Bitcoin’s position as a sound alternative to a system built on a precarious foundation of interminable fiscal deficits, credit encouragement, and rampant money printing.
Here are my key takeaways:
Bretton Woods was poorly designed and ill-fated from the start. Following World War II, the USD became the global reserve currency through the Bretton Woods agreement. This agreement required countries to guarantee convertibility of their currencies to USD, with USD then pegged to and exchangeable for gold bullion held by the US government. This system quickly proved to be unwieldy; as more money was printed, dollars became increasingly less pegged to reasonable amounts of gold. Gold’s challenges in portability, divisibility, and verifiability also hindered the system. As the dollar’s value debased, US gold reserves were rapidly depleted by increasing redemptions.
The modern fiat system is abstract, fragmented, and lacks scarcity. “Everything is a claim of a claim of a claim, reliant on perpetual motion and continual growth to not collapse (179).” Beginning in 1971, the current fiat regime now features 160 ever-devaluing currencies not backed by anything scarce, and each with its own siloed monetary policy. The current system is a circularity of liabilities that begets fragility:
If you have a bank account, that’s an asset for you and a liability for your bank, and it’s just an entry in your bank’s ledger. That bank account is backed up by the bank’s assets, which consist of various borrowers’ liabilities to the bank. The bank, meanwhile, stores its excess cash reserves as an asset at the Federal Reserve, which again is just an entry on Federal Reserve’s ledger. These cash reserves, being a liability of the Federal Reserve, are backed up the Federal Reserve’s assets, which primarily consist of U.S. Treasury securities. These U.S. Treasury securities are liabilities of the U.S. federal government and are primarily backed by the tax authority on its citizens and businesses within its jurisdiction (179).
The gap between transaction and settlement speeds is the main culprit. While everything else - energy abundance, technology abundance - has improved substantially, the disparity between transaction and settlement speeds remains. An international SWIFT wire is instantaneous, but the settlement can flow through 5 different banks and take up to 5 days to settle. Ever since the deployment of the intercontinental telecommunications system in the second half the 19th century, “this speed gap gave banks and governments a massive arbitrage opportunity through custodial monopolies over fast long-distance payments (300).”
Abstractions, fees, and middlemen bureaucracies ensued.
If only we could send and settle scarce value across borders in a matter of minutes without the need for intermediaries.
The US fiscal deficit is ‘sustainable’ so long as the money printer is kept on. The US is adding $1 trillion in debt every ~105 days. Federal spending on interest is forecast to hit $870B in 2024. The only way ‘out’ is for the Federal Reserve to expand the base money supply and purchase government bonds (i.e., debt monetization). The money supply grows at a faster rate than that of scarce goods and services which causes the prices of those goods and services to rise - i.e., inflation. Inflation leads to currency debasement which favors debtors, like the United States, over creditors. Why? The USD-denominated debt is devalued alongside the currency. Thus, the US is able to stave off a default in nominal terms, but the bondholders are paid back in weakened currency and lose purchasing power on their assets. The debtor wins.
The USD’s status as the global reserve currency affords the US more leeway in perpetuating its fiscal deficit. There is an extra layer of global demand for USD, most notably driven by the petrodollar system, or the US’ long-standing agreements with oil rich exporters to sell their barrels exclusively in USD and invest surplus profits in US treasuries. If the US was a company, it would be a junk bond. But that doesn’t deter global demand for its bonds.
Money printing is an opaque form of theft. It is less overt and understood than a tax increase. It consistently debases the savings of citizens to grease the wheels of the system. Rampant printing inflates away debts, but also funds wars and bailouts of stakeholders that are deemed systemically important; the bailouts of the banks in 2008 and the airlines in 2020 are recent examples of this.
Persistent inflation is a necessity for the current system. While intentional currency debasement through a 2% target inflation rate may seem counterintuitive, it’s the lynchpin in a highly leveraged system. The rationale is that consistent price increases encourage consumer borrowing and spending now vs. later, thus spurring economic growth. The government benefits from inflated asset prices as capital gains taxes are not adjusted for inflation. “When everything is built on massive amounts of debt, and policymakers keep intervening to make sure debt levels go ever higher, then deflation can collapse the system if it’s allowed to occur. (239)”
Bitcoin’s unforgeable costliness is its most unheralded property. Bitcoin’s headline properties are widely publicized and parroted at this point: transparent monetary policy, fixed supply, portable, divisible, fungible, globally accessible, censorship-resistant, etc. Come for the properties, stay for the network.
Less understood and discussed is the fact that the network reduces its risk of manipulation and gets stronger with each mined block. Mining requires significant computational power and energy consumption; the network is maintained by the real-world cost associated with mining. Manipulating the system would require a significant investment of resources: “The history of the ledger is unforgeable unless someone is willing and able to commit more processing power than the total of the entire history of the network to undo it (360).” Good luck.
Bitcoin’s much-maligned energy usage is a feature, not a bug. But it has also led to many misconceptions. The network currently consumes around 140-160 terawatt-hours of electricity annually, or 0.6% of the global electricity consumption. This % of the total isn’t expected to increase dramatically as (or if) Bitcoin becomes systemically important. Miner revenue as a % of total market cap has historically ranged from .03%-0.8%. At a $10 trillion market cap ($500k price), and assuming miner revenue is 0.5% of the market cap, the $50 billion in miner revenue would equate to 0.5% of global energy usage (taking into account growing global energy needs). At a $20 trillion market cap ($1mm price), $100 billion in miner revenue would equate to 1% of the global energy usage (385). In this scenario, the network would be used by hundreds of millions if not over a billion people.
In these outer scenarios, it becomes hard to argue that the network’s energy usage isn’t commensurate with its utility value.
Bitcoin uses cheap and stranded energy. Miners aren’t competing for energy and driving up prices in urban, coastal areas. Mining requires cheap electricity to be profitable. Thus, miners position their operations in close proximity to energy sources where they can buy on the low for 3-5 cents/kWh. Comparatively, the average electricity rate in California is 33 cents/kWh while the national average is 19 cents/kWh.
Further, miners target excess energy that would have otherwise been wasted. Stranded hydroelectric energy, natural gas, and landfill gas that would have generated no revenue for the operator is instead sold to and utilized by miners (393).
Stablecoins are a scaled innovation in efficient, cross-border, and non-volatile value transfer. But their requirement of fiat currency backing sacrifices the decentralization demonstrated by Bitcoin network.
Central governments have taken notice and are developing their own digital currencies (CBDCs). These currencies have frightening implications for surveillance and state control. Cash is the last bastion of privacy, the best vessel for untracked financing of nefarious activities. Understandably, governments, generally speaking, would prefer to eradicate cash in favor of a state-controlled digital currencies. But where the line gets drawn between crime prevention and human rights violations remains a question. With CBDCs, governments would conceivably be able to “tailor different monetary policies for different groups, automatically freeze accounts associated with certain people, and program someone’s money to shut off for certain categories or in certain geographies (462).”