Sound Money
Speakers: Michael Goldstein
Transcript By: Bryan Bishop
Tags: Altcoins
Introduction
In 2014, Michael appeared on MSNBC and gave this quote: “I’d only recommend using altcoins for speculation purposes if you really love risk, you’re absolutely in love with risk, and you’re interested in watching money disappear.” Today my talk is on sound money for the digital age. The concept of monetary economics is the reason why I got interested in bitcoin back in 2012. I still tihnk that’s the important thing that makes bitcoin important in the first place. I wanted to share some ideas around this.
Sound money
The biggest question is, what is sound money? You may have heard this term before. Usually people talk about in terms of “oh it’s money backed by gold and something real”, but it’s much more than that. A sound money is simply a money that was chosen by the marketplace rather than a money that was chosen by legislation or decree. Gold is a great example of money that has physical properties that made it useful as money so the market adopted it. Whereas fiat moneys are those that the government has said you must use as legal tender.
The big question is that when you’re trying to produce a money, like coming out with up out of the blue with code, we have to ask ourselves what makes sound money in the first place? What are the properties of a good money that makes the economy use it as the most liquid medium of exchange in the marketplace? A lot of us have heard many descriptions of good properties of money like durability, transporability, divisibility and others. To me, the most important one out of all of those, the lynchpin out of all, is the scarcity, which is one of the most wildly underappreciated properties of the universe.
Our friend Saifedean in The Bitcoin Standard gave a term “stop to flow ratio” which is from some old gold bug newsletters. It’s an extremely important concept that really brings together what it means to have a scarce good. The stock to flow ratio looks at the stock– how much of a given good is on the market at a given time? The flow is how many more units of that good will enter the marketplace over a given period of time. We recall something with a low stock to flow ratio, meaning many more given units enter in any given time period. Easy money means low stock-to-flow ratio. A hard money on the other hand is a high stock-to-flow ratio. Gold is a hard money because it’s hard not just because of the physical nature that it is a metal, but more importantly that it is extremely difficult to produce new units of gold and it enters the market in a pretty predictable rate generally speaking. Gold is really a soft metal, here.
When a market is trying to choose a medium of exchange, what works for people? If it has a low stock to flow ratio, that means that the value of that good gets diluted over time because if you have double the amount next year of a good, then clearly the value of each unit is going to be cut in half year over year. Over time, this makes it difficult to want to hold it for long periods of time. Meanwhile if you have a high stock to flow ratio, it’s quite the opposite: you know that the amount of goods on the market will not be diluted, if you’re holding on to it for whatever purpose, it…. it probably becomes more valuable, but it’s better at holding on to value for long periods of time. More people can do more types of economic planning with it.
Benefits of a sound money
What are the benefits of a sound money, instead of government decree money? With a government decreed money, they can choose at any time to change the monetary supply. This could come from good intentions, or it could be that they just want to hand out money to themselves. On the other hand, when you have a market-based currency, it tends to be based more on the laws of physics like “how much gold is there really” and “what is the difficulty of mining gold and turning it into coins”. And because of that, you have less expectation of the quantity being diluted, thus you can start to begin to think more deeply about the future.
An important concept in economics is called “time preference”, which is how much you don’t mind delaying gratification to get more later. There’s a classic marshmallow test where you can get one right now, but if you wait then you will get 2 later. A person with lower time preference can withstand the pain of sitting around for the second marshmallow, but a person with a high time preference would find that intolerable. If you have money being diluted at an unpredictable rate, you don’t want to take the risk of waiting around for the second marshmallow because you don’t know if it is going to come, so instead you want to put your money into other investments that you think will do better than holding on to cash. Meanwhile, if there’s nothing that you actually want, but there’s the expectation that the value will go down, it forces your hand to take up investments that you wouldn’t have otherwise taken because they are either higher risk or you’re just not interested. If you don’t have the fear of dilution, by comparison, and no unpredictable dilution, then you can look at the investments that really matter to you and bring the economic value that you really want. This opens up economic planning in the long-term. You can look farther into the future and get nicer things in general.
The very act of maintaining a fiat monetary policy requires having the belief that you know the correct balance between investings and savings. Right now, the reserve is pulling the levers in such a way that they want people to be investing in the economy for an economic stimulus or something like that, rather than putting into savings which you often hear aligned with words like “hoarding” which makes savings sound terrible but it’s a good thing which is why people actually want to do it. When people pull those levers, they imagine they know what that balance or parameter should be. But I would argue that nobody has the knowledge to really know what that balance should be. When you are hands off and you let the market develop their own money that people find value in, they will naturally find the equilibrium for savings and investment based on their individual time preferences.
When a money is printed ex nihilo, out of thin air, that money necessarily goes to one person first. It’s not like in a game of monopoly where the banker adds money to the economy and everyone gets $200. What happens is that someone is more politically connected to the central banker, and some people are less connected. What this means though is that for the people who first receive the money, the market has not adjusted to the new prices, and thus that person gets to spend the money without having— at the current prices before inflation kicks in. This is called the Cantillon effect. Because of these changes in people’s time preferences, there are mismatches in how people are giving out loans which also leads to economic cycles which is a deeper topic and maybe we can get into that in the Q&A if people are more interested.
Why bitcoin is sound money
Bitcoin by virtue of its design has a fixed supply of 21 million coins. Its network is completely decentralized, and run by individuals running nodes and they have consented to running those rules. Satoshi Nakamoto brilliantly engineered something called difficulty adjustment that creates predictable minting or issuance. With bitcoin, when there’s more mining, the difficulty of mining increases, thus new units of bitcoins do not magically show up. Instead, we have a very predictable issuance curve so that people know at a given time what the supply of bitcoin actually is and can actually predict this and bring it into their economic planning.
People often ask with regards to sound money and what makes good money, well what about volatility? Currently bitcoin is a bit volatile, obviously. However, I would argue that a sound money is a money that emerges in the market place. Stability is an emergent property that arises as a good becomes more liquid. It means that more economic trade can happen in that money, without impacting the price. This doesn’t need to be programmed into the network, it’s something that develops as the economy itself develops.
Why is bitcoin different?
There are ten gazillion alternative bitcoin copycats. The technical term is “shitcoin” as seen in the congressional record. Why bitcoin is different is that it has a strong monetary Schelling point. There’s 21 million coins. Everyone who enters the bitcoin economy knows that number, and it’s hard to get that out of your mind once it’s there. In addition, there’s a credible monetary policy. Chinese miners have not been able to change the rules of bitcoin; a bunch of American corporations trying to get together could not change the rules of bitcoin; the only things that can change the rules of bitcoin has been shown to be the full consent of the decentralized network. So the monetary policy is credible. Also, it is the most liquid of all cryptocurrencies. To look at this, look at the shitcoins priced in bitcoin not priced in USD. You can see how much bitcoin dominates them in the actual market. There’s also a feedback loop for various network effects, like brand recognition, developers, users, and so on. There is simply no competitor that even comes close.
Conclusion
So that’s a brief overview of why bitcoin is a sound money, and why it will continue to be because it’s different and better than anything else we’ve seen.