Dan Held is the founder of crypto portfolio service Picks & Shovels. He previously founded data service ZeroBlock, which sold to Blockchain, and served as VP of product at ChangeTip.
This exclusive opinion piece is part of CoinDesk's "Bitcoin at 10: The Satoshi White Paper" series.
Bitcoin's origin is akin to planting a tree.
It wasn't just Satoshi's selection of the species (code), but the season (timing), soil (distribution) and gardening (community) that were essential to its success. It had to grow to be strong, mighty and huge. It had to survive droughts, storms and predators. Its deep roots had to support the weight of becoming a new world reserve currency.
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What is Money?
Money is most easily defined as the medium in which value is transferred.
But money is not just paper in your hand, or numbers in your bank account, money represents something much more fundamental:
- Money is a primitive form of memory or record-keeping. It is the collective memory of who has the ability to allocate wealth.
- Money, which is the representation of the work required to acquire goods and services, can also be viewed as stored energy.
- Money is the central information utility of the world economy. As a medium of exchange, store of value, and unit of account, money is the critical vessel of information about the conditions of markets.
The main functions of money are Store of Value (SoV), Medium of Exchange (MoE), and Unit of Account (UoA). No money starts by providing all three functions, each new species of money follows a distinct evolutionary path that we will cover later. Let's first start by identifying the newest species of money, bitcoin.
Bitcoin is a new form of life, a new species of money called "cryptocurrency." More importantly, it is "sound money," or using proper taxonomy, "sanum pecuniam." Sound money is defined as money that has a purchasing power determined by markets, independent of governments and political parties which is essential for individual freedom.
The code of life is written into an organism at its inception. Satoshi carefully architected Bitcoin's DNA, or genetic code, to be the best sound money ever created.
We can think of bitcoin's genetic code as representing instructions that have been written to incentivize the organization and coordination of cellular function.
Bitcoin's genetic code:
- Satoshi needed a way for the bitcoin to spark itself into existence, so he coded in its DNA a fixed supply (21 million bitcoins). An increase in bitcoin's price inevitably leads to a corresponding increase in participants (users), security (mining), and developers. This becomes a self-reinforcing feedback loop.
- Bitcoin's mining function, proof-of-work (PoW) is both its metabolism and defense mechanism. Bitcoin eats energy to generate new coins and build digital walls to protect the network. PoW also makes bitcoin anti-fragile, or in other words, as it grows larger, it becomes more resistant to attack.
- A new bitcoin block is found every 10 minutes, this genetic code enables Bitcoin's cells to effectively communicate and coordinate with each other despite enormous distances. It is the internal clock that sets the metabolic rate.
Bitcoin's genetic code manifests itself via traits (characteristics of an organism) that may or may not be visible.
In biology, a trait or character is a feature of an organism.
According to Charles Darwin's theory of evolution by natural selection, organisms that possess heritable traits that enable them to better adapt to their environment compared with other members of their species will be more likely to survive, reproduce, and pass more of their genes on to the next generation.
Money is no different. Money has traits that enable it to survive and thrive as a Store of Value (SoV), Medium of Exchange (MoE), and Unit of Account (UoA). Bitcoin is a new species that has vastly superior traits to its predecessors. Below we dive deeper into those traits between different species of money.
Fiat currencies and gold are fairly easy to verify for authenticity.
However, despite providing features on their banknotes to prevent counterfeiting, nation-states and their citizens still face the potential to be duped by counterfeit bills. Gold is also not immune from being counterfeited.
Sophisticated criminals have used gold-plated tungsten as a way of fooling gold investors into paying for false gold. Bitcoins, on the other hand, can be verified with absolute mathematical certainty.
Gold provides the standard for fungibility.
When melted down, an ounce of gold is nearly indistinguishable from any other ounce. Fiat currencies, on the other hand, are only as fungible as the issuing institutions allow them to be. While it may be the case that a fiat banknote is usually treated like any other by merchants accepting them, there are instances where large-denomination notes have been treated differently to small ones.
For instance, India's government, in an attempt to stamp out India's untaxed gray market, completely demonetized their 500 and 1000 rupee banknotes. Bitcoins are fungible at the network level, meaning that every bitcoin, when transmitted, is treated the same on the Bitcoin network.
However, because bitcoins are traceable on the blockchain, a particular bitcoin may become tainted by its use in illicit trade and merchants or exchanges may be compelled not to accept such tainted bitcoins.
Despite this, there is no alternative pricing for "tainted Bitcoins" so it remains highly fungible.
Bitcoins are the most portable store of value ever used by man.
A single USB stick can contain a billion dollars, easily carried anywhere, transmitted near instantly. Fiat currencies, being fundamentally digital, are also highly portable.
However, governments can control the free flow of capital. Cash can be used to avoid capital controls, but then the risk of storage and cost of transportation become significant. Gold, being physical in form and incredibly dense, is by far the least portable.
When bullion is transferred between a buyer and a seller it is typically only the title to the gold that is transferred, not the physical bullion itself (It cost Germany $9.1 million to repatriate their gold).
Gold is the king of durability — the vast majority of gold that has ever been mined or minted, including the gold of the Pharaohs, remains today and will for near eternity (it can only be destroyed through nuclear transmutation).
While fiat currency exists both in physical and digital forms, we will only consider the durability of its digital form… the durability of the institution that issues them. Many fiat issuing governments have come and gone over the centuries, and their currencies disappeared with them.
If history is a guide, it would be folly to consider fiat currencies durable in the long term — the US dollar and British Pound are relative anomalies in this regard. Bitcoins, having no issuing authority, may be considered durable so long as the network that secures them remains in place. Given that Bitcoin is still in its infancy, it is too early to draw strong conclusions about its durability.
However, there are encouraging signs that the network displays a remarkable degree of "anti-fragility."
Bitcoins can be divided down to a hundred millionth of a bitcoin and transmitted at such infinitesimal amounts. Fiat currencies are typically divisible down to pocket change, which has little purchasing power, making fiat divisible enough in practice.
Gold, while physically divisible, becomes difficult to use when divided into small enough quantities that it could be useful for lower-value day-to-day trade.
The attribute that most clearly distinguishes Bitcoin from fiat currencies and gold is its predetermined absolute scarcity: only 21 million bitcoins can ever be created (the number of units is arbitrary, as bitcoins can be subdivided into 210 quadrillion satoshis).
This gives the owner of bitcoins a known percentage of the total possible supply. Gold, while remaining quite scarce through history, is not immune to increases in supply. If it were ever the case that a new method of mining or acquiring gold became economic, the supply of gold could rise dramatically (ex: sea-floor or asteroid mining).
Finally, fiat currencies, while only a relatively recent invention of history, have proven to be prone to constant increases in supply. Nation-states have shown a persistent proclivity to inflate their money supply to solve short-term political problems.
No monetary good has a history as long and storied as gold, which has been valued for as long as human civilization has existed. Coins minted in the distant days of antiquity still maintain significant value today.
The same cannot be said of fiat currencies, which are a relatively recent anomaly of history. From their inception, fiat currencies have had a near-universal tendency toward eventual worthlessness. The use of inflation as an insidious means of invisibly taxing a citizenry has been a temptation that no states in history have been able to resist.
Bitcoin, despite its short existence, has weathered enough trials in the market that there is a high likelihood it will not vanish as a valued asset any time soon. Furthermore, the Lindy effect suggests that the longer Bitcoin remains in existence the greater society's confidence that it will continue to exist long into the future. The median age of a human is ~30 years old, which means Bitcoin has been around for nearly 33.3% of the average human life.
If bitcoin exists for 20 years, there will be near-universal confidence that it will be available forever, much as people believe the Internet is a permanent feature of the modern world.
One of the most significant sources of early demand for bitcoins was their use in the illicit drug trade. Silk Road was a testament to this resistance.
The key attribute that makes bitcoin valuable for proscribed activities is that it is "permissionless" at the network level. When bitcoins are transmitted on the bitcoin network, there is no human intervention deciding whether the transaction should be allowed.
As a distributed peer-to-peer network, bitcoin is, by its very nature, designed to be censorship-resistant. This is in stark contrast to the fiat banking system, where states regulate banks and the other gatekeepers of money transmission to report and prevent outlawed uses of monetary goods. A classic example of regulated money transmission is capital controls.
A wealthy millionaire, for instance, may find it very hard to transfer their wealth to a new domicile if they wish to flee an oppressive regime (Russian assets in the UK being frozen). Although gold is not issued by states, its physical nature makes it difficult to transmit at distance, making it far more susceptible to state regulation than bitcoin.
India's Gold Control Act is an example of such regulation. If your mission is to disrupt central banks, you need to have sovereign level censorship resistance.
Money that is costly to create, due either to its original cost (gold mining) or the improbability of its history (art) — and that it is difficult to fake this costliness. Bitcoin's PoW ensures the cost to mine a Bitcoin is near equivalent to how much it would cost to purchase one on an exchange. The unforgeable costliness pattern includes the following basic steps:
"(1) find or create a class of objects that is highly improbable, takes much effort to make, or both, and such that the measure of their costliness can be verified by other parties.
(2) use the objects to enable a protocol or institution to cross trust boundaries" – Nick Szabo
Bitcoin is open-source; its design is public, it is usable by anyone/anywhere/anytime. Developers can freely program applications on top of the Bitcoin protocol without having to ask anyone for permission.
In it's simplest definition, decentralization means a lack of centralized control. Or the degree to which an entity within the system can resist coercion and still function as part of the system. Coercion doesn't necessarily mean force, it means negative incentives to align with an authority.
Decentralization is also important because it enables greater social scalability. The challenge is that natural systems inherently evolve towards centralization (hierarchies). We see this emergent property in cryptocurrencies as well. Hierarchy is an emergent property of networks. When we consider more complex systems, we must contend with more complex relationships between the layers. Quantifying decentralization is an especially thorny issue.
For a species of money to survive, it needs to be competitive on every attribute and be exceptionally better on a few of them. Attributes don't sum, they multiply.
When Gold was first introduced, the bead makers (an example of a more primitive form of money) probably tried to convince the ignorant population that gold was no substitute for beads. But it turned out that gold had traits that were more advantageous. It did not matter what anyone thought. Gold was destined to be a more powerful currency than shells or beads.
The fact that gold has remained a valued commodity for thousands of years speaks to the importance of these specific traits. In fact, the combination of traits possessed by gold and other precious metals eventually provided the foundation for the next evolution in money, fiat currency.
In money's next evolution of species, fiat currency fulfilled several critical traits to an even greater degree than gold. Paper was more portable and could be more easily transacted.
That is not to say it was entirely superior. In many cases, fiat currencies lacked durability, and as we will see, would eventually become less and less scarce (due to inflation). The critical flaw: its supply was controlled by kings and governments and increasingly used as a tool to wield power and control. Upon every new iteration of species, they each evolve in the following four stages (taken from "The Bullish Case for Bitcoin"):
- Collectible: In the very first stage of its evolution, money will be demanded solely based on its peculiar properties, usually becoming a whimsy of its possessor. Shells, beads and gold were all collectibles before later transitioning to the more familiar roles of money.
- Store of value: Once it is demanded by enough people for its peculiarities, money will be recognized as a means of keeping and storing value over time. As a good becomes more widely recognized as a suitable store of value, its purchasing power will rise as more people demand it for this purpose. The purchasing power of a store of value will eventually plateau when it is widely held and the influx of new people desiring it as a store of value dwindles.
- Medium of exchange: When money is fully established as a store of value, its purchasing power will stabilize. Having stabilized in purchasing power, the opportunity cost of using money to complete trades will diminish to a level where it is suitable for use as a medium of exchange.
- Unit of account: When money is widely used as a medium of exchange, goods will be priced in terms of it. I.e., the exchange ratio against money will be available for most goods.
Extinction can most simply be described as the failure of a species to compete in an environment to such at a degree that it eventually ceases to exist. The inability to compete itself may be the result of two primary causes; increased competition from superior species or a dramatic change in environment.
According to a study of 775 fiat currencies by DollarDaze.org the average life expectancy of a fiat currency is 27 years. The study also indicated the most common causes of any given currencies extinction are hyperinflation, monetary reform, war and independence.
Looking towards the fittest of fiat currencies, those that become reserve currencies, we find that most last just under 100 years. (Note: US currency only starts from 1933 because USD was redeemable for gold prior to that)
With fiat currencies being so susceptible to failure, gold has long served as an alternative as it is more scarce and durable. In terms of scarcity, fiat currencies can be printed and inflated at the will of their authorities.
The currencies are in a state of hyper-evolution as they continue to take on a varied array of distinctive traits that set them apart from one another within their own competitive ecosystem (fiat/crypto).
Equally as threatening to traditional forms of money, the conditions of the environment in which currencies compete is in a constant state of change. Undertones of growing distrust in centralized entities encourage populations to consider alternative stores of value.
Sovereignty, once a trait that was necessary for the survival of a currency, may now be falling out of favor. Centralized failures such as the US financial crisis of 2008 or hyper-inflated fiat currencies such as Zimbabwe dollars or Argentinian pesos compound these sentiments. The most profound of these conditions is the growing awareness throughout the world that decentralized trust is possible.
Instead of becoming anti-fragile, which is the property of growing stronger in a volatile and stressful environment, central banks have removed danger and mortality from failure, which causes competition to stagnate or degrade.
Sometimes stresses are so strong that they are fatal for a species of money. While this is devastating for the money itself, the population comprised of those that survive are fitter on average. This isn't because any of the survivors grew stronger from the stress, but simply because the weaker monies were removed.
It is interesting to imagine what Charles Darwin would make of the current state of money. History would have us believe that the existence and survival of any entity, be it plant, animal, corporation, or money is the subject to the laws of natural selection.
With this understanding, it is hard to imagine Darwin contesting the opinion that Bitcoin possesses the necessary traits to become the dominant species of money.
Bitcoin is perfectly honed for its environment through its exceptional genetic code and the manifestation of that code in the form of superior traits.
Bitcoin is the apex predator of money, and is constantly evolving. None of the previous monetary life forms stand a chance.
Part 2… (Season)
In Part 2, I will cover the season in which Bitcoin was planted — the 2008 financial crisis. Part 2 of this article will be published in the next few days and linked from Twitter via Tweet storm (follow me).