February 2019 Commentary
In this section I try to answer some of the criticisms against bitcoin from my friends who don’t actively invest in crypto-assets. One question I hear frequently is – I am already wealthy and have considerable investments in stocks, bonds and real estate. I consistently generate returns between 5 to 10%. I am happy with the current financial system as it is. Why should I care to invest in bitcoin?
This is a valid question. If someone is already happy with the returns he could still continue to invest in stock market. However, the last 10 years of proven that crypto as an asset class has the best 10-year, 5-year, and 2-year track record than any other asset class in the world. Numerous studies have also proven than Crypto assets as an asset class has performed with zero correlation to stocks, bonds, or real-estate. That is a good reason to hold portion of your portfolio in crypto assets. It has been established in another research study, that if you held even just 1% of your funds in crypto and the other 99% in cash, you would have outperformed all indices by a big margin.
But there is another good reason why everyone should hold a portion of their savings in bitcoin. This is based on monetary history and Economics. Austrian Economists like Murray Rothbard, Mises and F.A.Hayek have argued extensively that in a free market, multiple forms of money compete to be the main medium of exchange for a society. Each society chose a different commodity as their money. Some chose cows, sea shells, tobacco leaves, glass beads, huge carved stones, silver, copper and gold all have played the role of money in various human civilizations around the world. When various commodities compete to be the money in a free market, the commodity which has the highest stock-to-flow ratio always wins. Stock-to-flow ratio is essentially the inverse of inflation. The commodity whose supply grows the slowest (or the highest stock-to-flow ratio) is suitable as it loses the value the least
This picture shows a typical street in Venezuela. People are struggling for food and the capital city of Caracas did not have power for more than a week. All those pieces of paper, we see in the picture are Bolivars. Streets are filled with these printed notes and nobody wants them. People were working hard to save these little pieces of paper as a store-of-value of their labour. Obviously, it is not the fault of people that they used Bolivars to store their wealth, but the ignorant government that kept running the printing presses. But the price of this mistake was paid by all of the population who held their wealth in Bolivars. Those people who sought shelter from the storm in gold, US Dollars or bitcoin have survived just fine from this government induced hyper-inflation.
The implications of this are profound. In a society, if there are two competing currencies in a country, where currency A is inflating at a rate of 5% while the other currency B is inflating at a rate of 10%, what is the rational thing for a person to do? All those people who are holding either cash or other assets that are denominated in currency B, are going to lose the value against currency A. A person who is happily living with currency B for decades has no choice but to adopt currency A. This is not just idle economic theory. This can be seen in real life right now in those countries that are going through hyperinflation today like Venezuela, Turkey, Argentina and Iran. The dollar to bolivar conversion rate used to be close to 1:7 only 7 years ago. But now that ratio moved to 1: 3,800,000 in a matter of 6 years. Bolivar lost 99.99% of its purchasing power since April 2013. Even if there is a rich individual in Venezuela who is happy with his financial system in 2013, would have lost pretty much all of his wealth in a matter of 6 years for no fault. If he is prudent, he would have abandoned a currency that is growing at a rate of 30% and moved to the currency that is growing at a rate of 5% ( as is the case with US Dollars), his wealth would have been preserved. This is a zero-sum game, where the loss of purchasing power of Bolivars is equal to gain of dollars. Money leaks from high-inflation currency to low inflation currency just as water flows downhill due to gravity. This is an inevitable process of free markets driven by natural forces of incentives, which act like gravity.
If multiple currencies are available in a market, the person who uses the currency that inflates the least (or the hard money) will always win against easy money. The person who uses easy money to store his wealth will be bankrupted by the person who uses hard money. Austrian Economists conclusively demonstrated that it is not possible for a person to insulate himself fromthis kind of wealth destruction caused by holding easy money. The assets of the person who is holding assets denominated in dollars in Venezuela, hold their value while the person holding his assets in Bolivars is continuously depreciating. If this process continues for a long time, hard money holders are slowly acquiring the assets of the easy money holders. The person who is holding the easy money could be Mother Theresa and the person holding hard money could be a crook. Market does not make any moral judgement about the individuals. It will still bankrupt Mother Theresa and pass those assets into the hands of a crook.
According Ludwig Von Mises, the absence of control by government is a necessary condition for the soundness of money, seeing as government will have the temptation to debase its money whenever it begins to accrue wealth as savers invest in it. The Austrian theory of money posits that money emerges in a market as the most marketable commodity and most salable asset, the one asset whose holders can sell with the most ease, in favourable conditions. An asset that holds its value is preferable to an asset that loses value, and savers who want to choose a medium of exchange will gravitate towards assets that hold value over time as monetary assets. The network effects of money will eventually lead to one money to become the media of exchange. I have compared only two forms of money, Bolivars to US Dollars here. But this comparison can easily be extended to US Dollars to bitcoin.
Notice that volume of bitcoin traded in Venezuela went up by 10 times in one year, even though bitcoin trading volume is falling in many countries during 2018. The relationship between Bolivar to US Dollars is similar to US Dollars to bitcoin. US Dollars are expanding at a rate of 7% per year based on Federal Reserve’s own numbers. At this rate, in 10 years it halves the purchasing power of your US Dollars.
Until bitcoin’s invention, all forms of money were unlimited in their quantity and thus imperfect in their ability to store value across time. Even gold, the best money known to man, was expanding at a rate of 1.75%. Bitcoin’s immutable monetary supply makes it the best medium of store the value produced from the limited human time, thus making it arguably the best store of value humanity has ever invented. Around the year 2140, there will be no new supply of Bitcoin, and the stock-to-flow ratio of bitcoin becomes infinite, the first time any commodity or good has achieved this.It is inevitable that just as US Dollar won against Bolivars as hard money, bitcoin will win against US Dollar as form of money that is harder than US Dollar.