Why you should care about Bitcoin
There are so many interesting aspects to dig into when it comes to bitcoin. From personal experience, the discussion most often leads to blockchain, one of several functions on which bitcoin is based. Blockchain in all its glory, but with this blog post I want to introduce bitcoin’s “value proposition” and a big reason why the currency type exists, namely centrally controlled monetary policy. Today’s monetary policy is governed by central banks around the world and has been so for a long time. Attempts to control the economy by central banks have over time led to difficult economic crisis situations in the world, the most obvious of which may be the financial crisis in 2008. At the same time as the world’s financial system collapsed like a house of cards, an alternative financial system was created. Often refers to the Bitcoin network while bitcoin with a small “b” refers to the cryptocurrency used within the network).
Ägare av bitcoin kommer alltid att veta sin andel av det totala utbudet och det är någonstans här bilden av värde kommer in: värdet som skapas av det begränsade jämfört med av det obegränsade. Tänk analogin att äga originalet av Mona Lisa-tavlan gentemot att äga en kopia som tryckts i 10 000 exemplar.
Ever since the financial crisis, the central banks have affected our everyday lives to an increasing extent. By trying to slow down or accelerate the economy to smooth out economic cycles and act as a “Lender of Last Resort”, central banks have created a dependency on continuously stimulating the economy by increasing the money supply through various types of activities to curb threatening recessions. Lower interest rates, printed money and quantitative easing are types of measures that have created an environment where the money supply has skyrocketed exponentially, something that in the past year has led to a graph like a hockey stick. That graph is the big reason why I am writing this blog post. For today, it feels more relevant than ever to look up and try to understand the consequences of modern monetary policy.
Since the first bitcoin transaction was made in January 2009, the money supply in the US economy has more than doubled. A total of 10 trillion (10, 000, 000, 000, 000) dollars have been added, of which 3 trillion (3, 000, 000, 000, 000) dollars during the first half of 2020 as support measures due to the pandemic.
According to the theory of quantity, popularized by the economist Milton Friedman, there is a linear relationship between quantity and price level, ie if money in an economy doubles (inflation), price levels will also double (symptoms of inflation). In other words, the value of the products, services or assets does not increase, but instead the value of the currency deteriorates. Simply put, it can be seen as the products, services and assets available on the market absorbing the new influx of money like a sponge that absorbs water. As an example, you can compare how your favorite ice cream went up in price from when you were ten years old until today.
To prove the strength of the theory, we can compare the money supply increase of dollars with the amount of gold, which is a limited resource. In the last decade, the amount of gold mined has increased by only a few percent (the amount of gold increases when new gold is mined).
A simple thought experiment is to link inflation to dollars and gold and compare the price development of the S&P 500, an index that covers 500 large listed companies in the USA. If we measure the price of a share of the S&P 500 in dollars, it has risen by 500 percent since 1970. If we instead measure the price of a share of the S&P 500 in gold, it has fallen by around 40 percent from the same period.
Bitcoin – like gold in a fixed digital format
This is exactly where bitcoin comes into the picture as a form of “digital gold”. Bitcoin is the first digital artifact that has succeeded with the concept of creating a digital variant of money that is not controlled by a central player. Its limited range is very reminiscent of gold and is controlled by the laws of technology whose decentralization is a key word. The decentralization of the Bitcoin network means that several nodes participate and run the system worldwide. This in itself creates an enormous sluggishness and difficulty in making changes to the system. To change something, a majority of the Bitcoin network’s participants must choose to incorporate a certain proposed update, something that usually takes several months to years to implement. This also includes the monetary policy, or Bitcoin’s “monetary policy”, which has been encoded in Bitcoin’s source code since day one and which makes Bitcoin’s monetary policy predictable both in quantity and time. We know for sure the rate of inflation at any given time and that the last share of a bitcoin will be created in 2140 and can plan accordingly. Can we say the same about the dollar?
Bitcoin owners will always know their share of the total supply and this is where the image of value comes in: the value created by the limited as compared to by the unlimited. Imagine the analogy of owning the original of the Mona Lisa painting as opposed to owning a copy printed in 10,000 copies.
Is there ever a time when bitcoin’s “value proposition” should shine the strongest, it should be in these times when central banks around the world stimulate the nations’ economies with historically enormous liquidity injections. Like gold, bitcoin has seen a price increase that can be attributed to the abrupt increase in the money supply, ie inflation, in recent months.
Bitcoin is a fundamental transformation of every aspect of money. It’s the most abstract form of money we’ve ever created – Andreas Antonopolous
If we instead turn the picture upside down and put the dollar in focus, every dollar has lost value compared to gold and bitcoin. However, we do not need to limit the time frame to recent months. Ever since the US Federal Reserve was formed in 1913, the purchasing power of the dollar has been steadily declining in value – as can be clearly seen in the graph below.
Inflationary monetary policy has been around for a long time and the role of bitcoin as a hedge is growing stronger. The pandemic is not the only reason for this massive increase in the money supply. The money supply has increased and will most likely continue to increase over time, for the simple reason that today’s monetary system is designed to work that way. It also means that purchasing power will continue to decline in dollars and in all other fiat currencies worldwide. For some, this information is obvious, while for others it feels foreign. As carmaker Henry Ford put it:
It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning – Henry Ford
Whether there will be a revolution tomorrow morning or not, the fact remains: the need for an alternative preserver is more relevant than ever. Whether it will be bitcoin, gold or something completely different that takes on that role in the future remains to be seen.
Bitcoin’s value proposition becomes extra clear in times like these. The advantage of being a digital currency whose monetary policy is impossible to manipulate becomes increasingly apparent when we can compare it with central banks’ agile navigation methods to parry financial difficulties. With bitcoin, you will always know your share of the total 21,000,000 bitcoin that will be created, while the amount of money in fiat currencies has no ceiling.
As the quantity theory reminded us, the recurring stimuli will lead to a continuous deterioration of the value of fiat currencies and just like gold, bitcoin has an opportunity to continue to show its front feet as a value preserver as it has done for the past 10 years. But why bitcoin and not gold? That may be the next blog post…